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EX-31.1 - EXHIBIT 31.1 - SOUTH JERSEY GAS Coex31_1.htm
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EX-31.2 - EXHIBIT 31.2 - SOUTH JERSEY GAS Coex31_2.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-Q
(Mark one)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2011

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 000-22211

SOUTH JERSEY GAS COMPANY
(Exact name of registrant as specified in its charter)

New Jersey
 
21-0398330
(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)

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

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 o
Accelerated filer o
Non-accelerated filer x (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 August 1, 2011 there were 2,339,139 shares of the registrant’s common stock outstanding. All common shares are owned by South Jersey Industries, Inc., the parent company of South Jersey Gas Company.
                       


 
 

 
 

 
Page No.
   
PART I
FINANCIAL INFORMATION
 
     
Item 1.
3
     
Item 2.
18
     
Item 3.
27
     
Item 4.
28
     
PART II
OTHER INFORMATION
 
     
Item 1.
29
     
Item 1A.
29
     
Item 6.
29
     
29
 
 
SOUTH JERSEY GAS COMPANY

CONDENSED STATEMENTS OF INCOME (UNAUDITED)
(In Thousands)

 
   
Three Months Ended
June 30,
 
   
2011
   
2010
 
             
             
Operating Revenues
  $ 65,187     $ 61,344  
                 
Operating Expenses:
               
Cost of Sales (Excluding depreciation)
    28,259       23,941  
Operations
    17,403       16,485  
Maintenance
    3,215       2,785  
Depreciation
    7,523       7,319  
Energy and Other Taxes
    1,722       1,590  
                 
Total Operating Expenses
    58,122       52,120  
                 
Operating Income
    7,065       9,224  
                 
Other Income and Expense
    515       240  
                 
Interest Charges
    (4,895 )     (4,163 )
                 
Income Before Income Taxes
    2,685       5,301  
                 
Income Taxes
    (1,065 )     (2,125 )
                 
Net Income
  $ 1,620     $ 3,176  
 
The accompanying notes are an integral part of the unaudited condensed financial statements.
 
CONDENSED STATEMENTS OF INCOME (UNAUDITED)
(In Thousands)
 
   
Six Months Ended
June 30,
 
   
2011
   
2010
 
             
             
Operating Revenues
  $ 245,510     $ 258,060  
                 
Operating Expenses:
               
Cost of Sales (Excluding depreciation)
    116,833       140,816  
Operations
    35,676       34,292  
Maintenance
    6,224       5,601  
Depreciation
    14,983       14,398  
Energy and Other Taxes
    6,236       5,938  
                 
Total Operating Expenses
    179,952       201,045  
                 
Operating Income
    65,558       57,015  
                 
Other Income and Expense
    1,393       473  
                 
Interest Charges
    (9,924 )     (8,178 )
                 
Income Before Income Taxes
    57,027       49,310  
                 
Income Taxes
    (23,111 )     (20,264 )
                 
Net Income
  $ 33,916     $ 29,046  
 
The accompanying notes are an integral part of the unaudited condensed financial statements.
 
SOUTH JERSEY GAS COMPANY

CONDENSED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
(In Thousands)
 
   
Three Months Ended
June 30,
 
   
2011
   
2010
 
             
             
Net Income
  $ 1,620     $ 3,176  
                 
Other Comprehensive  Gain (Loss)   - Net of Tax:
               
                 
Unrealized Gain (Loss) on Available-for-Sale Securities
    50       (265 )
Unrealized Gain on Derivatives - Other
    7       7  
                 
Other Comprehensive Gain (Loss)  - Net of Tax *
    57       (258 )
                 
Comprehensive Income
  $ 1,677     $ 2,918  
                 
                 
   
Six Months Ended
June 30,
 
      2011       2010  
                 
                 
Net Income
  $ 33,916     $ 29,046  
                 
Other Comprehensive Loss  - Net of Tax:
               
                 
Unrealized Loss on Available-for-Sale Securities
    (103 )     (121 )
Unrealized Gain on Derivatives - Other
    14       14  
                 
Other Comprehensive Loss - Net of Tax *
    (89 )     (107 )
                 
Comprehensive Income
  $ 33,827     $ 28,939  

* Determined using a combined statutory tax rate of 41% .
 
The accompanying notes are an integral part of the unaudited condensed financial statements.
 
 
SOUTH JERSEY GAS COMPANY

 CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In Thousands)
 
   
Six Months Ended
June 30,
 
   
2011
   
2010
 
             
             
Net Cash Provided by Operating Activities
  $ 51,301     $ 63,574  
                 
Cash Flows from Investing Activities:
               
Capital Expenditures
    (55,611 )     (66,206 )
Net Proceeds from Sale of Restricted Investments in Margin Accounts
    994       -  
Investment in Long-Term Receivables
    (2,390 )     (1,529 )
Proceeds from Long-Term Receivables
    2,418       1,047  
                 
Net Cash Used in Investing Activities
    (54,589 )     (66,688 )
                 
Cash Flows from Financing Activities:
               
Net Borrowing from (Repayment of) Lines of Credit
    1,600       (53,900 )
Proceeds from Issuance of Long-Term Debt
    -       60,000  
Payments for Issuance of Long-Term Debt
    (28 )     (623 )
Dividend on Common Stock
    -       (2,500 )
                 
Net Cash Provided in Financing Activities
    1,572       2,977  
                 
Net Decrease in Cash and Cash Equivalents
    (1,716 )     (137 )
Cash and Cash Equivalents at Beginning of Period
    2,030       1,993  
                 
Cash and Cash Equivalents at End of Period
  $ 314     $ 1,856  
 
The accompanying notes are an integral part of the unaudited condensed financial statements.
 
 
6

 
SOUTH JERSEY GAS COMPANY

CONDENSED BALANCE SHEETS (UNAUDITED)
(In Thousands)
 
   
June 30,
2011
   
December 31,
2010
 
Assets
           
             
Property, Plant and Equipment:
           
Utility Plant, at original cost
  $ 1,437,113     $ 1,384,797  
Accumulated Depreciation
    (346,603 )     (337,993 )
                 
Property, Plant and Equipment - Net
    1,090,510       1,046,804  
                 
Investments:
               
Available-for-Sale Securities
    7,096       6,700  
Restricted Investments
    3,308       4,301  
                 
Total Investments
    10,404       11,001  
                 
Current Assets:
               
Cash and Cash Equivalents
    314       2,030  
Accounts Receivable
    71,132       37,619  
Accounts Receivable - Related Parties
    1,399       4,885  
Unbilled Revenues
    10,620       58,197  
Provision for Uncollectibles
    (4,545 )     (4,577 )
Natural Gas in Storage, average cost
    20,533       20,109  
Materials and Supplies, average cost
    2,644       2,511  
Prepaid Taxes
    24,860       15,907  
Derivatives - Energy Related Assets
    1,858       5,864  
Other Prepayments and Current Assets
    4,284       2,353  
                 
Total Current Assets
    133,099       144,898  
                 
Regulatory and Other Noncurrent Assets:
               
Regulatory Assets
    241,754       248,413  
Unamortized Debt Issuance Costs
    6,426       6,718  
Long-Term Receivables
    7,250       7,285  
Derivatives - Energy Related Assets
    119       1,005  
Other
    2,643       2,511  
                 
Total Regulatory and Other Noncurrent Assets
    258,192       265,932  
                 
Total Assets
  $ 1,492,205     $ 1,468,635  
 
The accompanying notes are an integral part of the unaudited condensed financial statements.

 
SOUTH JERSEY GAS COMPANY

CONDENSED BALANCE SHEETS (UNAUDITED)
(In Thousands, except per share amounts)
 
   
June 30,
2011
   
December 31,
2010
 
             
Capitalization and Liabilities
           
             
Common Equity:
           
Common Stock, Par Value $2.50 per share:
           
Authorized - 4,000,000 shares
           
Outstanding - 2,339,139 shares
  $ 5,848     $ 5,848  
Other Paid-In Capital and Premium on Common Stock
    200,841       200,841  
Accumulated Other Comprehensive Loss
    (9,209 )     (9,120 )
Retained Earnings
    263,232       229,316  
                 
Total Common Equity
    460,712       426,885  
                 
Long-Term Debt
    365,000       340,000  
                 
Total Capitalization
    825,712       766,885  
                 
Current Liabilities:
               
Notes Payable
    60,500       58,900  
Current Portion of Long-Term Debt
    25,000       50,000  
Accounts Payable - Commodity
    9,599       26,915  
Accounts Payable - Other
    24,616       19,628  
Accounts Payable - Related Parties
    9,315       10,830  
Derivatives - Energy Related Liabilities
    4,526       11,406  
Deferred Income Taxes - Net
    1,378       4,982  
Customer Deposits and Credit Balances
    18,469       10,525  
Environmental Remediation Costs
    19,384       25,662  
Taxes Accrued
    1,870       1,915  
Pension Benefits
    1,182       1,182  
Interest Accrued
    6,943       7,011  
Other Current Liabilities
    3,502       5,156  
                 
Total Current Liabilities
    186,284       234,112  
                 
Regulatory and Other Noncurrent Liabilities:
               
Regulatory Liabilities
    56,069       69,248  
Deferred Income Taxes - Net
    261,743       239,648  
Environmental Remediation Costs
    62,865       61,731  
Asset Retirement Obligations
    28,285       27,925  
Pension and Other Postretirement Benefits
    62,593       59,754  
Investment Tax Credits
    1,056       1,207  
Derivatives - Energy Related Liabilities
    185       430  
Derivatives - Other
    3,261       3,150  
Other
    4,152       4,545  
                 
Total Regulatory and Other Noncurrent Liabilities
    480,209       467,638  
                 
Commitments and Contingencies (Note 9)
               
                 
Total Capitalization and Liabilities
  $ 1,492,205     $ 1,468,635  
 
The accompanying notes are an integral part of the unaudited condensed financial statements.
 
 
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS

1.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

THE ENTITY - South Jersey Industries, Inc. (SJI) owns all of the outstanding common stock of South Jersey Gas Company (SJG), a regulated natural gas utility. SJG distributes natural gas in the seven southern most counties of New Jersey. In our opinion, the condensed financial statements reflect all normal and recurring adjustments needed to fairly present our financial position and operating results at the dates and for the periods presented. SJG’s business is 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, the accompanying condensed financial statements contain certain condensed financial information and exclude certain note disclosures normally included in annual audited financial statements prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). These condensed financial statements should be read in conjunction with SJG’s 2010 Form 10-K for a more complete discussion of our accounting policies and certain other information.

REVENUE BASED TAXES - SJG collects certain revenue-based energy taxes from its customers. Such taxes include New Jersey State Sales Tax, Transitional Energy Facility Assessment (TEFA) 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. TEFA and PUA are included in both revenues and cost of sales, and totaled $1.2 million and $1.1 million for the three months ended June 30, 2011 and 2010, and $5.0 million and $4.8 million for the six months ended June 30, 2011 and 2010, respectively.

NEW ACCOUNTING PRONOUNCEMENTS — Other than as described below, no new accounting pronouncement issued or effective during 2010 and 2011 had, or is expected to have, a material impact on the condensed financial statements.

The FASB has issued Accounting Standards Update (ASU) No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income.  This ASU allows an entity the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements.  In both choices, an entity is required to present each component of net income along with a total for other comprehensive income, and a total amount for comprehensive income.  ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity.  The new guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011.  Management is currently evaluating the impact that the adoption of this guidance will have on the Company’s financial statements.

2.
STOCK-BASED COMPENSATION PLANS:

The following table summarizes the SJI nonvested restricted stock awards pertaining to SJG outstanding at June 30, 2011, 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
 
                         
Jan. 2009
    8,318     $ 39.350       28.6 %     1.20 %
Jan. 2010
    10,024     $ 39.020       29.0 %     1.65 %
Jan. 2011
    7,544     $ 50.940       27.5 %     1.01 %
 
Expected volatility is based on the actual volatility of SJI’s share price over the preceding 3-year period as of the valuation date. The risk-free interest rate is based on the zero-coupon U.S. Treasury Bond, with a term equal to the 3-year term of the restricted shares. As notional dividend equivalents are credited to the holders, which are reinvested during the 3-year service period, no reduction to the fair value of the award is required.

The cost for restricted stock awards during 2011 and 2010 is approximately $0.1 million per quarter.

 
As of June 30, 2011, there was $0.6 million of total unrecognized compensation cost related to nonvested share-based compensation awards granted under the restricted stock plans. That cost is expected to be recognized over a weighted average period of 2.0 years.

The following table summarizes information regarding restricted stock award activity during the six months ended June 30, 2011, excluding accrued dividend equivalents:

   
Shares
   
Weighted
Average
Grant Date
Fair Value
 
Nonvested Shares Outstanding, January 1, 2011
   
18,342
   
$
39.170
 
                 
Granted
   
7,544
   
$
50.940
 
                 
Nonvested Shares Outstanding, June 30, 2011
   
25,886
   
$
42.600
 

During the six months ended June 30, 2011, SJG awarded 15,186 shares that had vested at December 31, 2010, to its officers at a market value of $0.8 million. During the six months ended June 2010, SJG awarded 14,400 shares at a market value of $0.5 million. SJG has a policy of making cash payments to SJI to satisfy its obligations under this plan. Cash payments to SJI during both the six months ended June 30, 2011 and 2010 were approximately $0.3 million relating to stock awards. Additionally, a change in control could result in the nonvested shares becoming nonforfeitable or immediately payable in cash.

3.
RATES AND REGULATORY ACTIONS:

SJG is subject to the rules and regulations of the New Jersey Board of Public Utilities (BPU).   The Company made a filing with the BPU in October 2010 requesting an extension of the Capital Investment Recovery Tracker (CIRT II).  The BPU approved a CIRT II program in March 2011, allowing the Company to accelerate an additional $60.3 million of capital spending into 2011 and 2012.  Under CIRT II, the Company capitalizes our return on CIRT II investments until they are recovered in rate base as utility plant in service.  On June 1, 2011 the Company filed a petition with the BPU requesting recovery of CIRT II investments through a 0.5% increase in base rates effective on October 1, 2011.  This petition is currently pending.

On March 29, 2011, SJG credited the accounts of our Basic Gas Supply Service (BGSS) customers with refunds totaling $21.1 million due to actual gas costs being lower than projected.

On June 1, 2011, the Company filed its annual BGSS clause and Conservation Incentive Program (CIP) filings with the BPU.  These petitions request a 2.9% reduction in rates for the BGSS and a 2.5% reduction in rates for the CIP, both commencing on October 1, 2011.  Also on June 1, 2011, the Company filed its annual Energy Efficiency Tracker (EET) petition, requesting a 0.5% increase.  These petitions are currently pending.

There have been no other significant regulatory actions or changes to SJG’s rate structure since December 31, 2010.  See Note 3 to the Financial Statements in Item 8 of SJG’s Form 10-K as of December 31, 2010.
 
4.
REGULATORY ASSETS AND LIABILITIES:

There have been no significant changes to the nature of SJG’s regulatory assets and liabilities since December 31, 2010, which are described in Notes 3 and 4 to the Financial Statements in Item 8 of SJG’s Form 10-K as of December 31, 2010.
 
 
Regulatory Assets consisted of the following items (in thousands):

   
June 30,
2011
   
December 31,
2010
 
Environmental Remediation Costs:
               
Expended - Net
 
$
43,817
   
$
39,056
 
Liability for Future Expenditures
   
82,249
     
87,393
 
Income Taxes - Flowthrough Depreciation
   
285
     
774
 
Deferred Asset Retirement Obligation Costs
   
24,550
     
24,247
 
Deferred Pension and Other Postretirement Benefit Costs
   
68,828
     
69,017
 
Conservation Incentive Program Receivable
   
2,846
     
12,291
 
Societal Benefit Costs Receivable
   
5,987
     
4,216
 
Premium for Early Retirement of Debt
   
618
     
699
 
Other Regulatory Assets
   
12,574
     
10,720
 
                 
Total Regulatory Assets
 
$
241,754
   
$
248,413
 

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

   
June 30,
2011
   
December 31,
2010
 
Excess Plant Removal Costs
  $ 47,843     $ 48,409  
Deferred Revenues - Net
    4,605       20,179  
Other Regulatory Liabilities
    3,621       660  
                 
Total Regulatory Liabilities
  $ 56,069     $ 69,248  

DEFERRED REVENUES – NET – Over/under collections of gas costs are monitored through SJG’s BGSS clause.  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 decreased from a $20.2 million regulatory liability at December 31, 2010 to a $4.6 million regulatory liability at June 30, 2011 primarily due to the BGSS refund to customers discussed above in Note 3, partially offset by gas costs recovered from customers exceeding the actual cost of the commodity incurred during the first six months of 2011 as a result of natural gas prices remaining at very low levels.

5.
RELATED PARTY TRANSACTIONS:

There have been no significant changes in the nature of SJG’s related party transactions since December 31, 2010. See Note 5 to the Financial Statements in Item 8 of SJG’s Form 10-K as of December 31, 2010 for a detailed description of such transactions.

A summary of related party transactions, excluding pass-through items, included in Operating Revenues were as follows, (in thousands):
 
   
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
   
2011
   
2010
   
2011
   
2010
 
Operating Revenues/Affiliates:
                       
SJRG
 
$
184
   
$
82
   
$
6,059
   
$
645
 
Other
   
167
     
109
     
484
     
235
 
Total Operating Revenue/Affiliates
 
$
351
   
$
191
   
$
6,543
   
$
880
 
 
 
Related party transactions, excluding pass-through items, included in Operating Expenses were as follows, (in thousands):

   
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
   
2011
   
2010
   
2011
   
2010
 
Costs of Sales/Affiliates (Excluding depreciation):
                       
SJRG
 
$
14,263
   
$
-
   
$
19,507
   
$
14,582
 
Energy-Related Derivative Losses *
                               
    SJRG
 
$
2,453
   
$
8,249
   
$
7,054
   
$
12,296
 

* Contracts used to hedge natural gas purchases. Included in Cost of Sales on the Condensed Statement of Income.

Operations Expense/Affiliates
                       
SJI
 
$
2,712
   
$
2,453
   
$
5,208
   
$
4,381
 
SJIS
   
1,131
     
959
     
2,273
     
2,462
 
Millennium
   
771
     
764
     
1,502
     
1,452
 
Other
   
(104
)
   
(64
)
   
(201
)
   
(118
)
Total Operations Expense/Affiliates
 
$
4,510
   
$
4,112
   
$
8,782
   
$
8,177
 

6.
FINANCIAL INSTRUMENTS:

Restricted Investments - In accordance with the terms of our tax-exempt first mortgage bonds, unused proceeds are required to be escrowed pending approved construction expenditures. As of both June 30, 2011 and December 31, 2010, the escrowed proceeds, including interest earned, totaled $0.1 million. The carrying amounts of the Restricted Investments approximate their fair value at June 30, 2011 and December 31, 2010. Beginning in the third quarter of 2010, SJG established a margin account with SJRG in conjunction with SJG's risk management activities as detailed in Note 11. The funds provided by SJG will increase or decrease as the number and value of outstanding energy-related contracts held with SJRG changes. As of June 30, 2011 and December 31, 2010, the balance held with SJRG totaled $3.2 million and $4.2 million, respectively.

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 $10.4 million as of both June 30, 2011 and December 31, 2010.  The current portion of these receivables is reflected in Accounts Receivable and the non-current portion is reflected in Long-Term Receivables on the balance sheet.  The carrying amounts noted above are net of unamortized discounts resulting from imputed interest in the amount of $1.2 million as of both June 30, 2011 and December 31, 2010.  The annual amortization to interest is not material to SJG’s financial statements.  The carrying amounts of these receivables approximate their fair value at June 30, 2011 and December 31, 2010.
 
Long-Term Debt – SJG did not issue any long-term debt during the first six months of 2011.  During the first six months of 2010, SJG issued $60.0 million aggregate principal amount of its Medium Term Notes in private placements due 2026.  As of both June 30, 2011 and December 31, 2010, $35.0 million remained available under this $150.0 million Medium Term Note program that was approved by the BPU in September 2009.

The estimated fair values of SJG’s long-term debt, including current maturities, as of June 30, 2011 and December 31, 2010, were $456.4 million and $455.5 million, respectively. We based the estimates on interest rates available to SJG at the end of each period for debt with similar terms and maturities. Carrying amounts as of both June 30, 2011 and December 31, 2010, were $390.0 million. We retire debt when it is cost effective as permitted by the debt agreements.  Our long-term debt agreements contain no financial covenants.
 
 
7.
UNUSED LINES OF CREDIT:

Credit facilities and available liquidity as of June 30, 2011 were as follows (in thousands):
 
   
Total Facility
   
Usage
   
Available Liquidity
 
Expiration Date
                     
Revolving Credit Facility
  $ 200,000     $ 40,500     $ 159,500  
May 2015 (A) (B)
Uncommitted Bank Lines
    20,000       20,000       -  
Various
                           
Total
  $ 220,000     $ 60,500     $ 159,500    

(A)  See Note 12 – Subsequent Event

(B) A new revolving credit facility was established by SJG in May 2011.  The SJG facility is a $200.0 million, four-year facility, provided by a syndicate of banks.  The facility contains one financial covenant limiting the ratio of indebtedness to total capitalization (as defined in the credit agreement) to not more than 0.65 to 1 measured at the end of each fiscal quarter.  SJG was in compliance with this covenant as of June 30, 2011. This facility replaces SJG’s $100.0 million revolving credit facility and $40.0 million committed line of credit, both of which would otherwise have expired in August of 2011.  See Note 12.

Average borrowings outstanding under these credit facilities during the six months ended June 30, 2011 and 2010 were $37.6 million and $84.5 million, respectively.  The maximum amount outstanding under these credit facilities during the six months ended June 30, 2011 and 2010 were $61.8 million and $112.5 million, respectively.

Based upon the existing credit facilities and a regular dialogue with our banks, we believe that there will continue to be sufficient credit available to meet our business’ future liquidity needs. Borrowings under these credit facilities are at market rates.  The weighted average borrowing cost, which changes daily, was 1.27% and 0.70% at June 30, 2011 and 2010, respectively.

8.
PENSION AND OTHER POSTRETIREMENT BENEFITS:

For the three and six months ended  June 30, 2011 and 2010, 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
June 30,
   
Six Months Ended
June 30,
 
   
2011
   
2010
   
2011
   
2010
 
Service Cost
 
$
696
   
$
664
   
$
1,481
   
$
1,326
 
Interest Cost
   
1,775
     
1,815
     
3,601
     
3,559
 
Expected Return on Plan Assets
   
(1,726
)
   
(1,753
)
   
(3,541
)
   
(3,251
)
Amortizations:
                               
Prior Service Cost
   
48
     
61
     
100
     
108
 
Actuarial Loss
   
1,048
     
776
     
2,057
     
1,838
 
Net Periodic Benefit Cost
   
1,841
     
1,563
     
3,698
     
3,580
 
Capitalized Benefit Costs
   
(902
)
   
(766
)
   
(1,812
)
   
(1,754
)
Total Net Periodic Benefit Expense
 
$
939
   
$
797
   
$
1,886
   
$
1,826
 


 
Other Postretirement Benefits
 
   
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
   
2011
   
2010
   
2011
   
2010
 
Service Cost
 
$
164
   
$
166
   
$
379
   
$
365
 
Interest Cost
   
597
     
611
     
1,216
     
1,297
 
Expected Return on Plan Assets
   
(408
)
   
(431
)
   
(854
)
   
(769
)
Amortizations:
                               
Prior Service Credits
   
(64
)
   
(67
)
   
(135
)
   
(141
)
Actuarial Loss
   
316
     
211
     
628
     
593
 
Net Periodic Benefit Cost
   
605
     
490
     
1,234
     
1,345
 
Capitalized Benefit Costs
   
(297
)
   
(240
)
   
(605
)
   
(659
)
Total Net Periodic Benefit Expense
 
$
308
   
$
250
   
$
629
   
$
686
 

Capitalized benefit costs reflected in the table above relate to our construction program.

No contributions were made to the pension plans during the six-month periods ending June 30, 2011. During May 2010, we contributed $6.4 million to our pension plans. We expect to make no contributions to our pension plans in 2011; however, changes in future investment performance and discount rates may ultimately result in a contribution.  We also have a regulatory obligation to contribute approximately $3.6 million annually to our other postretirement benefit plans’ trusts, less costs incurred directly by us.

See Note 11 to the Financial Statements in Item 8 of SJG’s Form 10-K as of December 31, 2010 for additional information related to SJG’s pension and other postretirement benefits.

9.
COMMITMENTS AND CONTINGENCIES:

STANDBY LETTER OF CREDIT -    SJG provided a $25.2 million letter of credit under a separate facility outside of the revolving credit facility to support variable-rate demand bonds issued through the NJEDA to finance the expansion of SJG’s natural gas distribution system.  As of December 31, 2010, these bonds were included in the current portion of long-term debt because this letter of credit expired in 2011.  The replacement letter of credit expires in August 2015, and as a result, the related bonds are now included in long-term debt as of June 30, 2011.

ENVIRONMENTAL REMEDIATION COSTS - SJG 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. There have been no changes to the status of SJG’s environmental remediation efforts since December 31, 2010, as described in Note 12 to the Financial Statements in Item 8 of SJG’s Form 10-K as of December 31, 2010.

GAS SUPPLY RELATED CONTRACTS - In the normal course of conducting business, we have entered into long-term contracts for natural gas supplies, firm transportation and gas storage service. The earliest that any of these contracts expire is October 2012. The transportation and storage service agreements between us and our interstate pipeline suppliers were made under FERC approved tariffs. Our cumulative obligation for demand charges and reservation fees paid to suppliers for these services is approximately $3.6 million per month and is recovered on a current basis through the BGSS.

 
PENDING LITIGATION - We are subject to claims arising in the ordinary course of business and other legal proceedings. 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. Management does not currently anticipate the disposition of any known claims to have a material adverse effect on our financial position, results of operations or liquidity.

COLLECTIVE BARGAINING AGREEMENTS - Unionized personnel represent approximately 64% of our workforce at June 30, 2011. The Company has collective bargaining agreements with two unions who represent these employees: the International Brotherhood of Electrical Workers (IBEW) that operates under a collective bargaining agreement that runs through February 2013, with the option to extend until February 2014 at the union’s election, and the International Association of Machinists and Aerospace Workers (IAM) that operates under a collective bargaining agreement that runs through  August 2014.

10.
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.

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 June 30, 2011
                       
   
Total
   
Level 1
   
Level 2
   
Level 3
 
                         
Assets -
                       
                         
Available-for-Sale Securities (A)
  $ 7,096     $ -     $ 7,096     $ -  
Derivatives – Energy Related Assets (B)
    1,977       619       1,358       -  
    $ 9,073     $ 619     $ 8,454     $ -  
                                 
Liabilities -
                               
                                 
Derivatives – Energy Related Liabilities (B)
  $ 4,711     $ 4,432     $ 279     $ -  
Derivatives – Other (C)
    3,261       -       3,261       -  
    $ 7,972     $ 4,432     $ 3,540     $ -  
 
 
As of December 31, 2010
                       
   
Total
   
Level 1
   
Level 2
   
Level 3
 
Assets
                       
Available-for-Sale Securities (A)
 
$
6,700
   
$
6,700
   
$
-
   
$
-
 
Derivatives – Energy Related Assets (B)
   
6,869
     
784
     
6,085
     
-
 
   
$
13,569
   
$
7,484
   
$
6,085
   
$
-
 
                                 
Liabilities
                               
Derivatives – Energy Related Liabilities (B)
 
$
11,836
   
$
10,614
   
$
1,222
   
$
-
 
Derivatives – Other (C)
   
3,150
     
-
     
3,150
     
-
 
   
$
14,986
   
$
10,614
   
$
4,372
   
$
-
 

 (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. 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, include interest rate swaps that 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.

11.
DERIVATIVE INSTRUMENTS:

SJG is involved in buying, selling, transporting and storing natural gas and is subject to market risk on expected future purchases and sales due to commodity price fluctuations. The Company, through its affiliate South Jersey Resources Group (SJRG), 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, futures contracts, swap agreements and options contracts. As of June 30, 2011, SJG had outstanding derivative contracts intended to limit the exposure to market risk on 14.2 MMdts of expected future purchases of natural gas. These contracts, which do not qualify for the normal purchase and sale exemption and 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 balance sheets. The costs or benefits of these short-term contracts are recoverable through SJG’s Basic Gas Supply Service (BGSS) clause, subject to BPU approval. As a result, the net unrealized pre-tax gains and losses for these energy related commodity contracts are included with realized gains and losses in Regulatory Assets or Regulatory Liabilities on the condensed balance sheets. As of June 30, 2011 and December 31, 2010, SJG had $2.7 million and $5.0 million of unrealized losses, respectively, included in its BGSS related to open financial contracts.

 
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, which have not been designated as hedging instruments under GAAP, are measured at fair value and recorded in Derivatives-Other on the condensed balance sheets. The fair value represents the amount SJG would have to pay the counterparty to terminate these contracts as of those dates. There have been no significant changes to the Company’s active interest rate swaps since December 31, 2010 which are described in Note 1 to the Financial Statements in Item 8 of SJG’s Annual Report on Form 10-K as of December 31, 2010. Subject to BPU approval, the market value upon termination of these interest rate derivatives can be recovered in rates and therefore these unrealized losses have been included in Regulatory Assets on the condensed balance sheets.

We previously used derivative transactions known as “Treasury Locks” to hedge against the impact on our cash flows of possible interest rate increases on debt issued in September 2005.  The initial $1.4 million cost of the Treasury Locks has been included in Accumulated Other Comprehensive Loss and is being amortized over the 30 year life of the associated debt issue.  As of June 30, 2011 and December 31, 2010, the unamortized balance was approximately $1.1 million.

The fair values of all derivative instruments, as reflected in the condensed balance sheets as of June 30, 2011 and December 31, 2010, are as follows (in thousands):

Derivatives not designated as hedging instruments under GAAP
 
June 30, 2011
   
December 31, 2010
 
   
Assets
   
Liabilities
   
Assets
   
Liabilities
 
Energy related commodity contracts:
                       
                         
Derivatives – Energy Related – Current
 
$
1,858
   
$
4,526
   
$
5,864
   
$
11,406
 
                                 
Derivatives – Energy Related – Non-Current
   
119
     
185
     
1,005
     
430
 
                                 
Interest rate contracts:
                               
                                 
Derivatives – Other
   
-
     
3,261
     
-
     
3,150
 
                                 
Total derivatives not designated as hedging instruments under GAAP
 
$
1,977
   
$
7,972
   
$
6,869
   
$
14,986
 
 
The effect of derivative instruments on the condensed statements of income for the three and six months ended June 30, 2011 and 2010 are as follows (in thousands):

   
Three months ended
June 30,
 
Six months ended
June 30,
 
Derivatives in Cash Flow Hedging Relationships Interest Rate Contracts:
 
2011
   
2010
 
2011
 
2010
 
                         
Losses reclassified from accumulated OCI into income (a)
 
$
(12
)
 
$
(12
)
 
$
(24
)
 
$
(24
)

(a) Included in Interest Charges

Net realized losses associated with SJG’s energy-related financial commodity contracts of $2.5 million and $8.2 million for the three months ended June 30, 2011 and 2010 and $7.1 million and $12.3 million for the six months ended June 30, 2011 and 2010, 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.

 
12.
SUBSEQUENT EVENT:
 
In July 2011, SJG began 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 will have fixed maturities which will vary by note, but may not exceed 270 days from the date of issue. Proceeds from the notes will be used for general corporate purposes. SJG intends to use the commercial paper program in tandem with its new $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.
 
Item 2. Management’s Discussion and Analysis
of Financial Condition and Results of Operations

OVERVIEW:

Organization - We are an operating public utility company engaged in the purchase, transmission and sale of natural gas for residential, commercial and industrial use. We also sell natural gas and pipeline transportation capacity (off-system sales) on a wholesale basis to various customers on the interstate pipeline system and transport natural gas purchased directly from producers or suppliers to their customers. We served 348,346 customers at June 30, 2011 compared with 344,752 customers at June 30, 2010.

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 by the Company 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 or suppliers to fulfill their contractual obligations; and changes in business strategies.

A discussion of these and other risks and uncertainties may be found in SJG’s Form 10-K for the year ended December 31, 2010 and in other filings made by us with the Securities and Exchange Commission. 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 SJG 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, SJG 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 financial statements and related disclosures. Actual results could differ from those estimates. Five types of transactions presented in our condensed financial statements require a significant amount of judgment and estimation. These relate to regulatory accounting, derivatives, environmental remediation costs, pension and other postretirement benefit costs, and revenue recognition. A discussion of these estimates and assumptions may be found in SJG’s Form 10-K for the year ended December 31, 2010.

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

Regulatory Actions – Other than the changes discussed in Note 3 to the condensed financial statements, there have been no significant regulatory actions since December 31, 2010. See detailed discussions concerning Regulatory Actions in Note 3 to the Financial Statements in item 8 of SJG’s Form 10-K for the year ended December 31, 2010.

Environmental Remediation –There have been no significant changes to the status of SJG’s environmental remediation efforts since December 31, 2010. See detailed discussion concerning Environmental Remediation in Note 12 to the Financial Statements in Item 8 of SJG’s Form 10-K for the year ended December 31, 2010.

Competition - See detailed discussion concerning competition in SJG’s Form 10-K for the year ended December 31, 2010.

Customer Choice Legislation - All residential natural gas customers in New Jersey can choose their natural gas commodity supplier under the terms of the “Electric Discount and Energy Competition Act of 1999.” This bill created the framework and necessary time schedules for the restructuring of the state’s electric and natural gas utilities. The Act established unbundling, under which redesigned utility rate structures allow natural gas and electric consumers to choose their energy supplier. Customers purchasing natural gas from a provider other than the local utility (marketer) are charged for the gas costs by the marketer and charged for the transportation costs by the utility. The number of customers purchasing their natural gas from marketers was 39,243 and 28,830 at June 30, 2011 and 2010, respectively.

RESULTS OF OPERATIONS:

The following table summarizes the composition of selected gas utility data for the three and six months ended June 30, (in thousands, except for degree day data):

   
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
   
2011
   
2010
   
2011
   
2010
 
Utility Throughput – dth:
                       
Firm Sales -
                       
Residential
   
2,514
     
2,309
     
13,755
     
13,740
 
Commercial
   
639
     
634
     
3,434
     
3,328
 
Industrial
   
27
     
24
     
182
     
172
 
Cogeneration & Electric Generation
   
434
     
356
     
554
     
400
 
Firm Transportation -
                               
Residential
   
317
     
207
     
1,570
     
1,189
 
Commercial
   
877
     
809
     
3,636
     
3,450
 
Industrial
   
3,191
     
3,254
     
6,636
     
6,343
 
Cogeneration & Electric Generation
   
1,125
     
803
     
3,526
     
2,996
 
                                 
Total Firm Throughput
   
9,124
     
8,396
     
33,293
     
31,618
 
                                 
Interruptible Sales
   
9
     
40
     
12
     
43
 
Interruptible Transportation
   
372
     
268
     
1,064
     
854
 
Off-System
   
1,551
     
1,921
     
3,455
     
3,037
 
Capacity Release
   
17,504
     
9,203
     
27,659
     
19,392
 
                                 
Total Throughput - Utility
   
28,560
     
19,828
     
65,483
     
54,944
 
 
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2011
 
2010
 
2011
 
2010
 
Utility Operating Revenues:
               
Firm Sales -
               
Residential
  $ 34,036     $ 31,845     $ 148,888     $ 169,360  
Commercial
    7,741       6,862       34,541       36,485  
Industrial
    574       206       2,294       2,001  
Cogeneration & Electric Generation
    2,692       2,273       3,501       2,684  
Firm Transportation -
                               
Residential
    2,313       1,502       8,863       5,956  
Commercial
    3,482       3,244       13,187       11,843  
Industrial
    4,270       4,675       8,665       8,651  
Cogeneration & Electric Generation
    745       709       2,487       2,718  
                                 
Total Firm Revenues
    55,853       51,316       222,426       239,698  
                                 
Interruptible Sales
    161       590       215       638  
Interruptible Transportation
    328       291       962       898  
Off-System
    7,314       8,622       17,448       15,546  
Capacity Release
    1,228       212       3,899       730  
Other
    303       313       560       550  
                                 
Total Utility Operating Revenues
    65,187       61,344       245,510       258,060  
                                 
Less:
                               
Cost of Sales
    28,259       23,941       116,833       140,816  
Conservation Recoveries*
    1,447       1,254       4,702       4,373  
RAC Recoveries*
    1,592       1,740       3,183       3,481  
EET Recoveries*
    635       359       1,144       538  
Revenue Taxes
    1,156       1,094       5,029       4,846  
Utility Margin
  $ 32,098     $ 32,956     $ 114,619     $ 104,006  
                                 
                                 
Margin:
                               
Residential
  $ 19,676     $ 14,783     $ 78,475     $ 60,083  
Commercial and Industrial
    9,239       6,764       30,566       21,722  
Cogeneration and Electric Generation
    765       679       1,540       1,388  
Interruptible
    39       76       87       114  
Off-system & Capacity Release
    233       68       928       377  
Other Revenues
    386       755       642       991  
Margin Before Weather Normalization & Decoupling
    30,338       23,125       112,238       84,675  
CIRT Mechanism
    626       2,538       1,192       4,562  
CIP Mechanism
    1,040       7,250       1,014       14,692  
EET Mechanism
    94       43       175       77  
Utility Margin
  $ 32,098     $ 32,956     $ 114,619     $ 104,006  
                                 
Degree Days:
    376       346       2,871       2,779  
 
*Represents expenses for which there is a corresponding credit in operating revenues.  Therefore, such recoveries have no impact on our financial results.
 
 
ThroughputTotal gas throughput increased  8.7 MMdts, or 44.0%, and 10.5 MMdts, or 19.2%, for the three and six months ended June 30, 2011, compared with the same periods in 2010, respectively.  These increases were realized primarily in the Capacity Release markets.   Capacity Release increased 8.3 MMdts in both the three and six months ended June 30, 2011, as compared with the same periods in 2010, respectively, as a result of increased opportunity for such sales.  Additional capacity became available during the latter part of 2010 as capacity previously transferred out of SJG under the provisions of the Conservation Incentive Program (CIP) was returned to the utility. Firm throughput increased  0.7 MMdts, or 8.7%, and 1.7 MMdts, or 5.3%, during the three and six months ended June 30, 2011, compared to the same periods in 2010, respectively.  This was primarily the result of weather that was 8.7% colder during the second quarter and 3.3% colder for the six months ended June 30, 2011, as compared with the same periods last year.  In addition, the Company added 3,594 customers over the twelve month period ended June 30, 2011, which represents a growth rate of 1.0%.
 
Conservation Incentive Program (CIP) - The effects of the CIP on our net income and the associated weather comparisons were as follows ($’s in millions):

   
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
   
2011
   
2010
   
2011
   
2010
 
Net Income Benefit:
                       
CIP – Weather Related
 
$
1.9
   
$
1.9
   
$
1.3
   
$
2.3
 
CIP – Usage Related
   
(1.3
)
   
2.4
     
(0.7
)
   
6.4
 
Total Net Income Benefit
 
$
0.6
   
$
4.3
   
$
0.6
   
$
8.7
 
                                 
Weather Compared to 20-Year Average
 
29.5% warmer
   
37.0% warmer
   
3.9% warmer
   
6.7% warmer
 
Weather Compared to Prior Year
 
8.7% colder
   
28.1% warmer
   
3.3% colder
   
7.3% warmer
 

Operating Revenues –
 
Revenues increased $3.8 million, or 6.3%, during the three months ended June 30, 2011 compared with the same period in the prior year.  Firm sales revenue increased $4.5 million, or 8.8%, during the second quarter of 2011 versus the second quarter of 2010, as the result higher firm throughput. As discussed previously under the caption “Throughput,” this increase was primarily the result of weather that was 8.7% colder during the second quarter of 2011 versus the same period in 2010, and the addition of approximately 3,600 customers over the twelve month period ended June 30, 2011.

A significant increase in Capacity Release throughput during the quarter, coupled with slightly higher pricing, contributed an incremental $1.0 million to revenue during the second quarter of 2011, as compared to the same period in 2010.  As previously stated under “Throughput,” this was made possible when additional capacity became available during the latter part of 2010, as capacity previously transferred out of SJG under the CIP was returned to SJG. Off-System Sales revenue decreased $1.3 million during the second quarter of 2011 versus the second quarter of 2010, as more of the newly available capacity was directed toward capacity release than OSS. As reflected in the Margin table above, the impact of the fluctuations in both Capacity Release and OSS did not have a material impact on the earnings of the Company, as SJG is required to share 85% of the profits of such activity with the ratepayers.

Revenues decreased $12.6 million, or 4.9%, during the six months ended June 30, 2011 compared with the same period in the prior year.  Firm sales revenue decreased $17.3 million, or 7.2%, during the first six months of 2011 versus the same period in 2010, as the result of lower natural gas costs experienced during 2011 which precipitated the return of $21.1 million in the form of a customer refund in March 2011.  The average cost of natural gas purchased during the first six months of 2011 was $6.26 per dt, representing a 9.3% decrease relative to the average cost of $6.90 per dt during the same period in 2010.

While changes in gas costs and BGSS recoveries may fluctuate from period to period, SJG does not profit from the sale of the commodity.  Therefore, corresponding fluctuations in Operating Revenue or Cost of Sales have no impact on Company profitability, as further discussed under “Margin.”

 
Partially offsetting the negative impact of the refund on revenues was the impact of adding approximately 3,600 customers over the last twelve months, and weather that was 3.3% colder during the first six months of 2011, as compared with the same period in 2010.

OSS revenue and capacity release revenue increased $1.9 million and $3.2 million, respectively, during the first six months of 2011 versus the same period in 2010, as both sales volume and capacity release unit prices increased. As previously stated under “Throughput,” this was made possible when additional capacity became available during the latter part of 2010, as capacity previously transferred out of SJG under the CIP was returned to SJG. As reflected in the Margin table above, the impact of the higher OSS did not have a material impact on the earnings of the Company, as SJG is required to share 85% of the profits of such activity with the ratepayers.

Margin (pre-tax) - SJG’s margin is defined as natural gas revenues less natural gas costs, regulatory rider expenses and related volumetric and revenue based energy taxes. SJG believes that margin provides a more meaningful basis for evaluating utility operations than revenues since natural gas costs, regulatory rider expenses and related energy expenses are passed through to customers, and therefore, they have no effect on margin. Natural gas costs are charged to operating expenses on the basis of therm sales at the prices approved by the New Jersey Board of Public Utilities through SJG’s BGSS clause.

Total margin decreased $0.9 million, or 2.6%, for the three months ended June 30, 2011, compared with the same period in 2010 primarily due to a change in the timing of profits earned through the Company’s Capital Investment Recovery Tracker (CIRT).   The CIRT was approved by the BPU in April 2009 and allows the Company to accelerate certain capital spending and also earn a return of, and a return on, investment at the time the investment is made. A significant portion of revenues previously recovered through the CIRT were rolled into base rates in September 2010 resulting in decreased recoveries under the CIRT program in 2011. The impact of the base rate case effectively shifted more recoveries into the first and fourth quarters, with no impact on annual net income. The CIRT added $0.6 million of pre-tax margin in the second quarter of 2011, compared with $2.5 million in the same period of 2010.

As discussed in Note 3 to the condensed financial statements, the BPU approved a CIRT II program in March 2011.  Under this program, recoveries of our investments are not included in margin.  However, they are reflected in both Other Income and as a reduction to interest expense until the BPU approves recovery in base rates.

The CIP protected $1.0 million of pre-tax margin in the second quarter of 2011 that would have been lost due to lower customer usage, compared with $7.3 million in the same period last year.  Of these amounts, $3.2 million were related to weather variations in both periods and $(2.2) million and $4.1 million were related to other customer usage variations in 2011 and 2010, respectively. A significant portion of revenues previously recovered through the CIP were rolled into base rates resulting in decreased recoveries under this program in the second quarter of 2011.  As noted above, the impact of the base rate case effectively shifted more recoveries into the first and fourth quarters, with no impact on annual net income.

Total margin increased $10.6 million, or 10.2% for the six months ended June 30, 2011 compared with the same period in 2010 primarily due to the base rate increase granted in September 2010, higher margins from OSS and capacity release and customer additions.  The CIRT added $1.2 million of pre-tax margin in the first half of 2011, compared with $4.6 million in the same period last year. As noted above, certain revenues previously recovered through the CIRT were rolled into base rates in September 2010 resulting in decreased recoveries under this program in 2011.

 
The CIP protected $1.0 million of pre-tax margin in the first half of 2011 that would have been lost due to lower customer usage, compared with $14.7 million in the same period last year.  Of these amounts, $2.2 and $3.9 million were related to weather variations and $(1.2) and $10.8 million were related to other customer usage variations in 2011 and 2010, respectively. As noted above, certain revenues previously recovered through the CIP were rolled into base rates resulting in decreased recoveries under this program in 2011.

Operating Expenses - A summary of changes in operating expenses (in thousands):

   
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
   
2011 vs. 2010
   
2011 vs. 2010
 
             
Operations
 
$
918
   
$
1,384
 
Maintenance
   
430
     
   623
 
Depreciation
   
204
     
   585
 
Energy and Other Taxes
   
132
     
   298
 

Operations  – Operations expense increased $0.9 million and $1.4 million for the three and six months ended June 30, 2011, respectively, as compared with the same periods in 2010.  The increases are primarily due to several factors as follows:

 
·
Spending under the New Jersey Clean Energy Program and Energy Efficiency Programs increased $0.5 million and $0.9 million for the three and six months ended June 30, 2011, respectively, as compared to 2010.  Such costs are recovered on a dollar-for-dollar basis; therefore, SJG experienced an offsetting increase in revenues during the period.  

 
·
Amortization of previously deferred regulatory expenses increased $0.3 million and $0.6 million during the three and six three and six months ended June 30, 2011, respectively, as compared to 2010. Recovery of these costs was approved in the Company’s September 2010 rate case settlement; therefore, such cost recognition is offset by a corresponding increase in revenue.  

 
·
The Company also experienced increases in various other areas including general compensation increases and corporate support, governance and compliance costs, primarily attributable to our parent, SJI. 

 
·
Finally, the reserve for uncollectible customer accounts had decreased $0.7 million during the first quarter of 2011, as compared to the first quarter of 2010, due to a $21.1 million customer refund in March 2011. However, as customer account receivable balances returned to more typical levels during the second quarter of 2011, the benefit of the first quarter reserve adjustment had to be reversed.  Changes in the uncollectible reserve are the direct result of fluctuations in levels of customer account receivable balances.

Partially offsetting the expense increases noted above were lower expense associated with the write-off of uncollectible customer accounts receivable.  These expenses were $0.7 million and $0.5 million less for the three and six months ended June 30, 2011, respectively, as a result of significant write-offs during the second quarter of 2010, which stemmed from a post-winter season evaluation of delinquent accounts. Following the March 2011 customer refund of $21.1 million and lower natural gas costs, as discussed under “Operating Revenues,” a similar action was not required in 2011.

 
Maintenance -   Maintenance expense increased $0.4 million and $0.6 million during the three and six months ended June 30, 2011, compared with the same periods in 2010, respectively, due to the BPU-approved amortization and recovery of previously deferred maintenance costs, primarily those associated with a federally mandated pipeline integrity management program.  Such amortizations, which are being recovered through an offsetting amount in revenues beginning in September 2010, totaled $0.3 million and $0.6 million during the three and six months ended June 30, 2011, respectively.  The Company also incurred increased maintenance costs in other areas of operations; however, these increases were partially offset by lower levels of Remediation Adjustment Clause (RAC) amortization.  RAC-related expenses do not affect earnings either, as we recognize an offsetting amount in revenues.

Depreciation - Depreciation expense increased $0.2 million and $0.6 million during the three and six months ended June 30, 2011, as compared with the same periods in 2010, respectively, due mainly to SJG’s continuing investment in utility plant.

Energy and Other Taxes - Energy and Other Taxes increased $0.1 million and $0.3 million during the three and six months ended June 30, 2011, compared with the same periods in 2010, respectively, primarily due to higher taxable firm throughput in 2011.  This resulted from colder weather and a 1.0% increase in the number of customers served over the twelve month period ended June 30, 2011.  Additional weather information can be found above under the caption “Conservation Incentive Program (CIP).”

Other Income and Expense - Other Income and Expense increased $0.3 million and $0.9 million during the three and six months ended June 30, 2011, compared with the same periods in 2010, respectively.  With the approval of the Company’s CIRT II in March, 2011, the company was permitted to recognize interest on construction on its qualified incremental spending.  While the debt-related component of the interest charge is credited against interest charges, the equity-related component of the interest charge is recognized as Other Income.  This incremental income totaled $0.2 million, most of which occurred during the second quarter.  In addition, SJG recognized a gain of $0.6 million on the sale of certain available-for-sale securities during the first quarter of 2011.

Interest Charges –  Interest Charges increased $0.7 million and $1.7 million during the three and six months ended June 30, 2011, compared with the same periods in 2010, respectively, primarily due to the issuance of $115.0 million aggregate principal long-term debt issued during 2010 at higher interest rates than the short-term debt previously used to finance our capital program.
 
LIQUIDITY AND CAPITAL RESOURCES:

Liquidity needs are driven by factors that include natural gas commodity prices; the impact of weather on customer bills; lags in fully collecting gas costs from customers under the Basic Gas Supply Service charge; the timing of construction and remediation expenditures and related permanent financings; mandated tax payment dates; both discretionary and required repayments of long-term debt; and the amounts and timing of dividend payments.
 
Cash Flows from Operating Activities - Liquidity needs are first met with net cash provided by operating activities.  Net cash provided by operating activities totaled $51.3 million and $63.6 million in the first halves of 2011 and 2010, respectively.  Net cash provided by operating activities varies from year-to-year primarily due to the impact of weather on customer demand and related gas purchases, customer usage factors related to conversion efforts and the price of the natural gas commodity, inventory utilization, and gas cost recoveries.  Net cash provided by operations was negatively impacted by the $21.1 million BGSS bill credit posted to customer accounts at the end of the first quarter and higher-than-normal gas commodity purchases late in 2010, due to colder weather, that were paid in 2011.  These negative impacts were offset by tax benefits which resulted in lower cash tax payments during the period.

Cash Flows from Investing Activities - SJG has a continuing need for cash resources for capital purchases, primarily to invest in new and replacement facilities and equipment. Cash used for capital purchases was $55.6 million and $66.2 million during the first six months of 2011 and 2010, respectively.   We estimate the net cash outflows for construction projects for fiscal years 2011, 2012 and 2013 to be approximately $138.8 million, $73.8 million and $56.0 million, respectively.  For capital expenditures, including those under the CIRT, SJG will use short-term borrowings to finance capital expenditures as incurred.  From time to time, the Company will refinance the short-term debt incurred to support capital expenditures with long-term debt.

 
Cash Flows from Financing Activities - SJG uses short-term borrowings under lines of credit from commercial banks to supplement cash from operations, to support working capital needs and to finance capital expenditures as incurred. From time to time, the Company refinances short-term debt incurred to finance capital expenditures with long-term debt. Debt is incurred primarily to expand and upgrade our gas transmission and distribution system and to support seasonal working capital needs related to inventories and customer receivables.

Credit facilities and available liquidity as of June 30, 2011 were as follows (in thousands):

   
Total
Facility
   
Usage
   
Available
 Liquidity
 
Expiration Date
                     
Revolving Credit Facility
 
$
200,000
   
$
40,500
   
$
159,500
 
May 2015 (A) (B)
Uncommitted Bank Lines
   
20,000
     
20,000
     
  Various
                           
Total
 
$
220,000
   
$
60,500
   
$
159,500
   

(A)   See Note 12 - Subsequent Event to the Condensed Financial Statements.

(B)   A new revolving credit facility was established by SJG in May 2011.  The SJG facility is a $200.0 million, four-year facility, provided by a syndicate of banks.  The facility contains one financial covenant limiting the ratio of indebtedness to total capitalization (as defined in the credit agreement) to not more than 0.65 to 1, measured at the end of each fiscal quarter.  SJG was in compliance with this covenant as of June 30, 2011. This facility replaces SJG’s $100.0 million revolving credit facility and $40.0 million committed line of credit, both of which would otherwise have expired in August of 2011.

Average borrowings outstanding under these credit facilities during the six months ended June 30, 2011 and 2010 were $37.6 million and $84.5 million, respectively.  The maximum amount outstanding under these credit facilities during the six months ended June 30, 2011 and 2010 were $61.8 million and $112.5 million, respectively.

Based upon the existing credit facilities and a regular dialogue with our banks, we believe there will continue to be sufficient credit available to meet our future liquidity needs.

SJG supplements its operating cash flow and credit lines with both debt and equity capital. Over the years, SJG has used long-term debt, primarily in the form of First Mortgage Bonds and Medium Term Notes (MTN), secured by the same pool of utility assets, to finance our long-term borrowing needs. These needs are primarily capital expenditures for property, plant and equipment. In March and June 2010, SJG issued $15.0 million and $45.0 million aggregate principal amount of its MTNs under private placements.  No other long-term debt was issued during the first six months of 2011 or 2010.

SJG’s capital structure was as follows:

   
As of
June 30,
2011
   
As of
December 31,
2010
 
             
Common Equity
   
50.6
%
   
48.8
%
Long-Term Debt
   
42.8
     
44.5
 
Short-Term Debt
   
6.6
     
6.7
 
                 
Total
   
100.0
%
   
100.0
%


COMMITMENTS AND CONTINGENCIES:

SJG has a continuing need for cash resources and capital, primarily to invest in new and replacement facilities and equipment, working capital, and for environmental remediation costs. Cash outflows for capital expenditures for the first six months of 2011 amounted to $55.6 million. Management estimates net cash outflows for construction projects for 2011, 2012 and 2013, to be approximately $138.8 million, $73.8 million and $56.0 million, respectively.  Costs for remediation projects, net of insurance reimbursements, for the first six months of 2011 amounted to net cash outflows of $8.1 million.  Total cash outflows for remediation projects are expected to be $18.6 million, $11.7 million and $9.8 million for 2011, 2012, and 2013, respectively.  As discussed in Notes 4 and 12 to the Financial Statements in Item 8 of SJG’s 10-K as of December 31, 2010, environmental remediation costs are subject to recovery from insurance carriers and ratepayers.

SJG provided a $25.2 million letter of credit under a separate facility, outside of the revolving credit facility to support variable-rate demand bonds issued through the NJEDA to finance the expansion of SJG's natural gas distribution system.  As of December 31, 2010, these bonds were included in the current portion of long-term debt because this letter of credit expired in 2011.  The replacement letter of credit expires in August 2015, and as a result, the related bonds are now included in long-term debt as of June 30, 2011.

In the normal course of business, SJG entered into a long-term contract for natural gas supplies.  SJG has committed to purchase a minimum of 6,250 dts/d and up to 25,000 dts/d of natural gas, from one supplier, for a term of eight years at index-based prices.

SJG has certain commitments for both pipeline capacity and storage demand charges for which it pays fees regardless of usage. Those commitments as of June 30, 2011, average $43.3 million annually and total $170.8 million over the contracts’ lives.  Approximately 20% of the financial commitments under these contracts expire during the next five years. SJG expects to renew each of these contracts under renewal provisions as provided in each contract. SJG recovers all prudently incurred fees through rates via the Basic Gas Supply Service clause.

Contractual Cash Obligations –   Details concerning contractual cash obligations may be found in SJG’s Form 10-K for the year ended December 31, 2010.  There were no significant changes to SJG’s contractual cash obligations in 2011 except for commodity supply purchase obligations which increased by approximately $38.6 million since December 31, 2010. Obligations for natural gas commodity can fluctuate from period to period primarily due to the seasonal demand and the timing of entering into such supply commitments.

Off-Balance Sheet Arrangements - We have no off-balance sheet arrangements.

Pending Litigation - We are subject to claims arising in the ordinary course of business and other legal proceedings. We accrue liabilities related to claims when we can determine the amount or range of amounts of probable settlement costs. Management does not currently anticipate the disposition of any known claims to have a material adverse effect on our financial position, results of operations or liquidity.
 
Ratio of Earnings to Fixed Charges - Our ratio of earnings to fixed charges for each of the periods indicated is as follows:

Twelve Months
Ended June 30,
   
Year Ended December 31,
 
2011
   
2010
   
2009
   
2008
   
2007
   
2006
 
                                 
5.0x
     
5.1x
      </