UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10‑Q
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 1‑8359 | ||
NEW JERSEY RESOURCES CORPORATION | ||
(Exact name of registrant as specified in its charter) | ||
New Jersey | 22‑2376465 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification Number) | |
1415 Wyckoff Road, Wall, New Jersey 07719 | 732‑938‑1480 | |
(Address of principal executive offices) | (Registrant's telephone number, including area code) | |
Securities registered pursuant to Section 12 (b) of the Act: | ||
Common Stock ‑ $2.50 Par Value | New York Stock Exchange | |
(Title of each class) | (Name of each exchange on which registered) |
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 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 | Smaller reporting company: o |
(Do not check if a smaller reporting company) |
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
The number of shares outstanding of $2.50 par value Common Stock as of August 2, 2011 was 41,436,473.
New Jersey Resources Corporation
TABLE OF CONTENTS
Page | |||
PART I - FINANCIAL INFORMATION | |||
ITEM 1. | |||
ITEM 2. | |||
ITEM 3. | |||
ITEM 4. | |||
PART II - OTHER INFORMATION | |||
ITEM 1. | |||
ITEM 1A. | |||
ITEM 2. | |||
ITEM 4. | |||
ITEM 6. | |||
New Jersey Resources Corporation
INFORMATION CONCERNING FORWARD-LOOKING STATEMENTS ��
Certain statements contained in this report, including, without limitation, statements as to management expectations and beliefs presented in Part I, Item 2. “Management's Discussion and Analysis of Financial Condition and Results of Operations,” Part I, Item 3. “Quantitative and Qualitative Disclosures about Market Risk,” Part II, Item I. “Legal Proceedings” and in the notes to the financial statements are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements can also be identified by the use of forward-looking terminology such as “may,” “intend,” “expect,” “believe,” "will" or “continue” or comparable terminology and are made based upon management's current expectations and beliefs as of this date concerning future developments and their potential effect upon New Jersey Resources Corporation (NJR or the Company). There can be no assurance that future developments will be in accordance with management's expectations or that the effect of future developments on the Company will be those anticipated by management.
The Company cautions readers that the assumptions that form the basis for forward-looking statements regarding customer growth, customer usage, qualifications for federal investment tax credits (ITCs) and Solar Renewable Energy Certificates (SRECs), financial condition, results of operations, cash flows, capital requirements, market risk and other matters for fiscal 2011 and thereafter include many factors that are beyond the Company's ability to control or estimate precisely, such as estimates of future market conditions, the behavior of other market participants and changes in the debt and equity capital markets. The factors that could cause actual results to differ materially from NJR's expectations include, but are not limited to, those discussed in Risk Factors in Item 1A of NJR's 2010 Annual Report on Form 10-K and Part II, Item 1A of this Form 10-Q, as well as the following:
• | weather and economic conditions; |
• | NJR's dependence on operating subsidiaries; |
• | demographic changes in the New Jersey Natural Gas (NJNG) service territory; |
• | the rate of NJNG customer growth; |
• | volatility of natural gas and other commodity prices and their impact on customer usage, NJNG's incentive programs, NJR Energy Services' (NJRES) operations and on the Company's risk management efforts; |
• | changes in rating agency requirements and/or credit ratings and their effect on availability and cost of capital to the Company; |
• | the impact of volatility in the credit markets that would result in the increased cost and/or limit the availability of credit at NJR to fund and support physical gas inventory purchases and other working capital needs at NJRES, and all other non-regulated subsidiaries, as well as negatively affect cost and access to the commercial paper market and other short-term financing markets by NJNG to allow it to fund its commodity purchases, capital expenditures and meet its short-term obligations as they come due; |
• | the ability to comply with debt covenants; |
• | continued failures in the market for auction rate securities; |
• | the impact to the asset values and resulting higher costs and funding obligations of NJR's pension and postemployment benefit plans as a result of downturns in the financial markets, and impacts associated with the Patient Protection and Affordable Care Act; |
• | accounting effects and other risks associated with hedging activities and use of derivatives contracts; |
• | commercial and wholesale credit risks, including the availability of creditworthy customers and counterparties and liquidity in the wholesale energy trading market; |
• | the ability to obtain governmental approvals and/or financing for the construction, development and operation of certain non-regulated energy investments, including our solar energy projects; |
• | risks associated with the management of the Company's joint ventures and partnerships; |
• | risks associated with our investments in solar energy projects, including the availability of regulatory and tax incentives, logistical risks and potential delays related to construction, permitting, regulatory approvals and electric grid interconnection, the availability of viable projects and NJR's eligibility for ITCs and the future market for SRECs; |
• | timing of qualifying for ITCs due to delays or failures to complete planned solar energy projects would result in a change in our effective tax rate and earnings; |
• | the level and rate at which costs and expenses are incurred and the extent to which they are allowed to be recovered from customers through the regulatory process in connection with constructing, operating and maintaining NJNG's natural gas transmission and distribution system; |
• | dependence on third-party storage and transportation facilities for natural gas supply; |
• | operating risks incidental to handling, storing, transporting and providing customers with natural gas; |
• | access to adequate supplies of natural gas; |
• | the regulatory and pricing policies of federal and state regulatory agencies; |
• | the costs of compliance with present and future environmental laws, including potential climate change-related legislation; |
• | the ultimate outcome of pending regulatory proceedings; |
• | the disallowance of recovery of environmental-related expenditures and other regulatory changes; and |
• | environmental-related and other litigation and other uncertainties. |
While the Company periodically reassesses material trends and uncertainties affecting the Company's results of operations and financial condition in connection with its preparation of management's discussion and analysis of results of operations and financial condition contained in its Quarterly and Annual Reports, the Company does not, by including this statement, assume any obligation to review or revise any particular forward-looking statement referenced herein in light of future events.
Page 1
New Jersey Resources Corporation
Part I
ITEM 1. FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
Three Months Ended | Nine Months Ended | |||||||||||
June 30, | June 30, | |||||||||||
(Thousands, except per share data) | 2011 | 2010 | 2011 | 2010 | ||||||||
OPERATING REVENUES | ||||||||||||
Utility | $ | 138,149 | $ | 105,130 | $ | 862,073 | $ | 794,311 | ||||
Nonutility | 510,020 | 374,764 | 1,476,235 | 1,213,475 | ||||||||
Total operating revenues | 648,169 | 479,894 | 2,338,308 | 2,007,786 | ||||||||
OPERATING EXPENSES | ||||||||||||
Gas purchases: | ||||||||||||
Utility | 74,385 | 47,665 | 469,835 | 478,719 | ||||||||
Nonutility | 482,735 | 393,126 | 1,460,600 | 1,114,842 | ||||||||
Operation and maintenance | 38,811 | 37,077 | 114,123 | 110,386 | ||||||||
Regulatory rider expenses | 6,518 | 6,160 | 47,520 | 41,017 | ||||||||
Depreciation and amortization | 8,514 | 8,136 | 25,445 | 23,936 | ||||||||
Energy and other taxes | 10,024 | 6,516 | 60,138 | 50,275 | ||||||||
Total operating expenses | 620,987 | 498,680 | 2,177,661 | 1,819,175 | ||||||||
OPERATING INCOME (LOSS) | 27,182 | (18,786 | ) | 160,647 | 188,611 | |||||||
Other income | 1,176 | 1,311 | 2,426 | 3,458 | ||||||||
Interest expense, net of capitalized interest | 4,744 | 5,238 | 15,085 | 15,946 | ||||||||
INCOME (LOSS) BEFORE INCOME TAXES AND EQUITY IN EARNINGS OF AFFILIATES | 23,614 | (22,713 | ) | 147,988 | 176,123 | |||||||
Income tax provision (benefit) | 6,197 | (10,555 | ) | 48,662 | 68,066 | |||||||
Equity in earnings of affiliates | 2,957 | 1,981 | 9,484 | 7,885 | ||||||||
NET INCOME (LOSS) | $ | 20,374 | $ | (10,177 | ) | $ | 108,810 | $ | 115,942 | |||
EARNINGS (LOSS) PER COMMON SHARE | ||||||||||||
BASIC | $0.49 | $(0.25) | $2.63 | $2.80 | ||||||||
DILUTED | $0.49 | $(0.25) | $2.62 | $2.78 | ||||||||
DIVIDENDS PER COMMON SHARE | $0.36 | $0.34 | $1.08 | $1.02 | ||||||||
WEIGHTED AVERAGE SHARES OUTSTANDING | ||||||||||||
BASIC | 41,381 | 41,239 | 41,338 | 41,424 | ||||||||
DILUTED | 41,597 | 41,239 | 41,551 | 41,703 |
See Notes to Unaudited Condensed Consolidated Financial Statements
Page 2
New Jersey Resources Corporation
Part I
ITEM 1. FINANCIAL STATEMENTS (Continued)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Nine Months Ended | |||||||
June 30, | |||||||
(Thousands) | 2011 | 2010 | |||||
CASH FLOWS FROM OPERATING ACTIVITIES | |||||||
Net income | $ | 108,810 | $ | 115,942 | |||
Adjustments to reconcile net income to cash flows from operating activities: | |||||||
Unrealized loss on derivative instruments | 53,503 | 6,186 | |||||
Depreciation and amortization | 25,445 | 24,628 | |||||
Allowance for equity used during construction | (1,252 | ) | (1,474 | ) | |||
Allowance for bad debt expense | 3,365 | 2,277 | |||||
Deferred income taxes | 22,110 | 69,329 | |||||
Manufactured gas plant remediation costs | (10,818 | ) | (2,925 | ) | |||
Equity in earnings of affiliates, net of distributions received | (470 | ) | (2,261 | ) | |||
Cost of removal - asset retirement obligations | (711 | ) | (676 | ) | |||
Contributions to postemployment benefit plans | (9,591 | ) | (7,866 | ) | |||
Changes in: | |||||||
Components of working capital | 5,311 | (54,205 | ) | ||||
Other noncurrent assets | 11,951 | 9,891 | |||||
Other noncurrent liabilities | 19,568 | (2,902 | ) | ||||
Cash flows from operating activities | 227,221 | 155,944 | |||||
CASH FLOWS (USED IN) INVESTING ACTIVITIES | |||||||
Expenditures for | |||||||
Utility plant | (69,894 | ) | (49,696 | ) | |||
Solar equipment | (17,529 | ) | — | ||||
Real estate properties and other | (2,423 | ) | (460 | ) | |||
Cost of removal | (8,075 | ) | (6,252 | ) | |||
Investments in equity investees | — | (4,300 | ) | ||||
Withdrawal from restricted cash construction fund | 67 | — | |||||
Cash flows (used in) investing activities | (97,854 | ) | (60,708 | ) | |||
CASH FLOWS (USED IN) FINANCING ACTIVITIES | |||||||
Proceeds from issuance of common stock | 10,507 | 6,414 | |||||
Tax benefit from stock options exercised | 355 | (96 | ) | ||||
Proceeds from sale-leaseback transaction | 5,901 | 4,925 | |||||
Payments of long-term debt | (25,690 | ) | (4,683 | ) | |||
Purchases of treasury stock | (7,222 | ) | (28,069 | ) | |||
Payments of common stock dividends | (43,747 | ) | (39,160 | ) | |||
Net (payments) proceeds of short-term debt | (9,600 | ) | 20,900 | ||||
Cash flows (used in) financing activities | (69,496 | ) | (39,769 | ) | |||
Change in cash and temporary investments | 59,871 | 55,467 | |||||
Cash and temporary investments at beginning of period | 943 | 36,186 | |||||
Cash and temporary investments at end of period | $ | 60,814 | $ | 91,653 | |||
CHANGES IN COMPONENTS OF WORKING CAPITAL | |||||||
Receivables | $ | (97,566 | ) | $ | (82,253 | ) | |
Inventories | 87,210 | 18,222 | |||||
Recovery of gas costs | 36,329 | (77,529 | ) | ||||
Gas purchases payable | 12,856 | 90,976 | |||||
Prepaid and accrued taxes | 15,654 | (14,093 | ) | ||||
Accounts payable and other | 11,857 | 330 | |||||
Restricted broker margin accounts | (36,544 | ) | 24,172 | ||||
Customers' credit balances and deposits | (16,341 | ) | (17,137 | ) | |||
Other current assets | (8,144 | ) | 3,107 | ||||
Total | $ | 5,311 | $ | (54,205 | ) | ||
SUPPLEMENTAL DISCLOSURES OF CASH FLOWS INFORMATION | |||||||
Cash paid for | |||||||
Interest (net of amounts capitalized) | $ | 9,778 | $ | 10,426 | |||
Income taxes | $ | 4,138 | $ | 23,811 |
See Notes to Unaudited Condensed Consolidated Financial Statements
Page 3
New Jersey Resources Corporation
Part I
ITEM 1. FINANCIAL STATEMENTS (Continued)
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
ASSETS
(Thousands) | June 30, 2011 | September 30, 2010 | ||||
PROPERTY, PLANT AND EQUIPMENT | ||||||
Utility plant, at cost | $ | 1,560,944 | $ | 1,525,348 | ||
Real estate properties, solar and other, at cost | 51,766 | 33,497 | ||||
Total property, plant and equipment | 1,612,710 | 1,558,845 | ||||
Accumulated depreciation and amortization | (407,156 | ) | (423,126 | ) | ||
Property, plant and equipment, net | 1,205,554 | 1,135,719 | ||||
CURRENT ASSETS | ||||||
Cash and cash equivalents | 60,814 | 943 | ||||
Customer accounts receivable | ||||||
Billed | 258,811 | 162,961 | ||||
Unbilled revenues | 7,310 | 7,411 | ||||
Allowance for doubtful accounts | (4,541 | ) | (2,993 | ) | ||
Regulatory assets | 9,531 | 51,466 | ||||
Gas in storage, at average cost | 248,136 | 336,163 | ||||
Materials and supplies, at average cost | 6,887 | 6,070 | ||||
Prepaid state taxes | 40,622 | 55,880 | ||||
Asset held for sale | 1,579 | — | ||||
Derivatives, at fair value | 59,018 | 135,186 | ||||
Restricted broker margin accounts | 27,326 | 19,241 | ||||
Deferred taxes | 7,151 | — | ||||
Other | 19,023 | 12,680 | ||||
Total current assets | 741,667 | 785,008 | ||||
NONCURRENT ASSETS | ||||||
Investments in equity investees | 172,977 | 169,234 | ||||
Regulatory assets | 438,729 | 454,601 | ||||
Derivatives, at fair value | 5,081 | 7,957 | ||||
Other | 9,948 | 10,614 | ||||
Total noncurrent assets | 626,735 | 642,406 | ||||
Total assets | $ | 2,573,956 | $ | 2,563,133 |
See Notes to Unaudited Condensed Consolidated Financial Statements
Page 4
New Jersey Resources Corporation
Part I
ITEM 1. FINANCIAL STATEMENTS (Continued)
CAPITALIZATION AND LIABILITIES
(Thousands) | June 30, 2011 | September 30, 2010 | ||||
CAPITALIZATION | ||||||
Common stock equity | $ | 796,280 | $ | 725,483 | ||
Long-term debt | 428,200 | 428,925 | ||||
Total capitalization | 1,224,480 | 1,154,408 | ||||
CURRENT LIABILITIES | ||||||
Current maturities of long-term debt | 12,224 | 31,257 | ||||
Short-term debt | 138,000 | 147,600 | ||||
Gas purchases payable | 243,258 | 230,402 | ||||
Accounts payable and other | 59,526 | 47,297 | ||||
Dividends payable | 14,901 | 13,998 | ||||
Deferred and accrued taxes | 27,695 | 23,737 | ||||
New Jersey clean energy program | 14,725 | 12,644 | ||||
Derivatives, at fair value | 45,138 | 78,447 | ||||
Restricted broker margin accounts | — | 28,459 | ||||
Customers' credit balances and deposits | 75,616 | 91,957 | ||||
Total current liabilities | 631,083 | 705,798 | ||||
NONCURRENT LIABILITIES | ||||||
Deferred income taxes | 304,250 | 278,551 | ||||
Deferred investment tax credits | 6,308 | 6,549 | ||||
Deferred revenue | 9,051 | 7,656 | ||||
Derivatives, at fair value | 4,029 | 5,640 | ||||
Manufactured gas plant remediation | 201,600 | 201,600 | ||||
Postemployment employee benefit liability | 95,090 | 93,742 | ||||
Regulatory liabilities | 58,053 | 57,648 | ||||
New Jersey clean energy program | 6,723 | 18,291 | ||||
Asset retirement obligation | 26,540 | 26,009 | ||||
Other | 6,749 | 7,241 | ||||
Total noncurrent liabilities | 718,393 | 702,927 | ||||
Commitments and contingent liabilities (Note 13) | ||||||
Total capitalization and liabilities | $ | 2,573,956 | $ | 2,563,133 |
See Notes to Unaudited Condensed Consolidated Financial Statements
Page 5
New Jersey Resources Corporation
Part I
ITEM 1. FINANCIAL STATEMENTS (Continued)
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
Three Months Ended | Nine Months Ended | |||||||||||
June 30, | June 30, | |||||||||||
(Thousands) | 2011 | 2010 | 2011 | 2010 | ||||||||
Net income (loss) | $ | 20,374 | $ | (10,177 | ) | $ | 108,810 | $ | 115,942 | |||
Unrealized (loss) gain on available for sale securities, net of tax of $141, $(85), $(411) and $(698), respectively (1) | (205 | ) | 131 | 595 | 1,010 | |||||||
Net unrealized gain (loss) on derivatives, net of tax of $(1), $76, $(56) and $119, respectively | 2 | (120 | ) | 97 | (182 | ) | ||||||
Other comprehensive (loss) income | (203 | ) | 11 | 692 | 828 | |||||||
Comprehensive income (loss) | $ | 20,171 | $ | (10,166 | ) | $ | 109,502 | $ | 116,770 |
(1) | Available for sale securities are included in Investments in equity investees in the Unaudited Condensed Consolidated Balance Sheets. |
See Notes to Unaudited Condensed Consolidated Financial Statements
Page 6
New Jersey Resources Corporation
Part I
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. | NATURE OF THE BUSINESS |
New Jersey Resources Corporation (NJR or the Company) provides regulated gas distribution services and certain non-regulated businesses primarily through the following subsidiaries:
New Jersey Natural Gas Company (NJNG) provides natural gas utility service to approximately 495,300 retail customers in central and northern New Jersey and is subject to rate regulation by the New Jersey Board of Public Utilities (BPU). NJNG comprises the Natural Gas Distribution segment;
NJR Energy Services Company (NJRES) comprises the Energy Services segment that maintains and transacts around a portfolio of natural gas storage and transportation positions and provides wholesale energy and energy management services;
NJR Energy Holdings Corporation (NJREH) primarily invests in energy-related ventures through its subsidiaries, NJNR Pipeline Company (Pipeline), which holds the Company's 5.53 percent ownership interest in Iroquois Gas and Transmission System, L.P. (Iroquois) and NJR Steckman Ridge Storage Company, which holds the Company's 50 percent combined interest in Steckman Ridge GP, LLC and Steckman Ridge, LP (collectively, Steckman Ridge). Iroquois and Steckman Ridge comprise the Midstream Assets segment;
Effective October 1, 2010, NJR established Clean Energy Ventures (CEV) as a new segment to report the results of operations and assets related to the Company's expected capital investments in renewable energy projects. NJR Clean Energy Ventures (NJRCEV) comprises the Clean Energy Ventures segment (see Note 14. Business Segment and Other Operations).
NJR Retail Holdings Corporation (Retail Holdings) has two principal subsidiaries, NJR Home Services Company (NJRHS) and Commercial Realty & Resources Corporation (CR&R). Retail Holdings and NJR Energy Corporation (NJR Energy) are also included in Retail and Other operations.
2. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES |
The accompanying Unaudited Condensed Consolidated Financial Statements have been prepared by NJR in accordance with the rules and regulations of the Securities and Exchange Commission (SEC). The September 30, 2010 Balance Sheet data is derived from the audited financial statements of the Company. These Unaudited Condensed Consolidated Financial Statements should be read in conjunction with the financial statements and the notes thereto included in NJR's 2010 Annual Report on Form 10-K.
The Unaudited Condensed Consolidated Financial Statements include the accounts of NJR and its subsidiaries. In the opinion of management, the accompanying Unaudited Condensed Consolidated Financial Statements reflect all adjustments necessary, for a fair presentation of the results of the interim periods presented. These adjustments are of a normal and recurring nature. Because of the seasonal nature of NJR's utility and wholesale energy services operations, in addition to other factors, the financial results for the interim periods presented are not indicative of the results that are to be expected for the fiscal year ended September 30, 2011.
Intercompany transactions and accounts have been eliminated.
Gas in Storage
The following table summarizes Gas in storage by company as of:
June 30, 2011 | September 30, 2010 | |||||||||||
($ in thousands) | Gas in Storage | Bcf | Gas in Storage | Bcf | ||||||||
NJNG | $ | 94,666 | 14.2 | $ | 181,098 | 24.7 | ||||||
NJRES | 153,470 | 34.8 | 155,065 | 42.3 | ||||||||
Total | $ | 248,136 | 49.0 | $ | 336,163 | 67.0 |
Page 7
New Jersey Resources Corporation
Part I
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Capitalized and Deferred Interest
Included in the Unaudited Condensed Consolidated Balance Sheets are capitalized amounts associated with the debt and equity components of NJNG's allowance for funds used during construction (AFUDC), which are recorded in utility plant. NJNG's base rates include the ability for NJNG to recover the cost of debt associated with AFUDC and construction work in progress (CWIP). An incremental cost of equity is also recoverable during periods when NJNG's short-term debt balances are lower than its construction work in progress. Corresponding amounts recognized in interest expense and other income, as appropriate, are included in the Unaudited Condensed Consolidated Statements of Operations are as follows:
Three Months Ended | Nine Months Ended | |||||||||||
June 30, | June 30, | |||||||||||
($ in thousands) | 2011 | 2010 | 2011 | 2010 | ||||||||
AFUDC: | ||||||||||||
Debt | $ | 352 | $ | 262 | $ | 622 | $ | 662 | ||||
Equity | 753 | 557 | 1,252 | 1,474 | ||||||||
Total | $ | 1,105 | $ | 819 | $ | 1,874 | $ | 2,136 | ||||
Weighted average rate | 7.76 | % | 7.76 | % | 5.57 | % | 7.34 | % |
Pursuant to a BPU order, NJNG is permitted to recover carrying costs on uncollected balances related to Societal Benefits Clause (SBC) program costs, which include New Jersey Clean Energy Program (NJCEP), Remediation Adjustment (RA) and Universal Service Fund (USF) expenditures (see Note 3. Regulation). Accordingly, other income included $275,000 and $374,000 of deferred interest related to these SBC program costs for the three months ended June 30, 2011 and 2010, respectively, and $794,000 and $1.3 million for the nine months ended June 30, 2011 and 2010, respectively.
Customer Accounts Receivable
Customer accounts receivable include outstanding billings from the following subsidiaries as of:
($ in thousands) | June 30, 2011 | September 30, 2010 | |||||||||
NJNG (1) | $ | 52,056 | 20 | % | $ | 17,983 | 11 | % | |||
NJRES | 196,335 | 76 | 136,064 | 83 | |||||||
NJRHS and other | 10,420 | 4 | 8,914 | 6 | |||||||
Total | $ | 258,811 | 100 | % | $ | 162,961 | 100 | % |
(1) | Does not include unbilled revenues of $7.3 million and $7.4 million as of June 30, 2011 and September 30, 2010, respectively. |
Asset Held for Sale
As of June 30, 2011, NJR has classified a property located in Monmouth County as held for sale in the Unaudited Condensed Consolidated Balance Sheets. The property is approximately 4.5 acres of undeveloped land with a net book value of $1.6 million, which is expected to be sold during the fourth quarter of fiscal 2011.
Recent Updates to the Accounting Standards Codification (ASC)
Consolidation:
In June 2009, the Financial Accounting Standards Board (FASB) issued guidance requiring qualitative evaluations including an additional emphasis on identifying the party who effectively controls the entity, which replaces the quantitative assessments previously in practice, when determining whether a company has a controlling financial interest in a variable interest entity (VIE). In addition, the assessments will be required on an ongoing basis, rather than limiting the reassessments to when certain triggering events occur. Additional disclosures provide information on a company's involvement with VIE's. The Company adopted the provisions of the statement prospectively during its first quarter of fiscal 2011 and the adoption had no impact on its financial position, results of operations or cash flows.
Page 8
New Jersey Resources Corporation
Part I
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Fair Value
In May 2011, the FASB issued an amendment to ASC Topic 820, Fair Value Measurements and Disclosures, clarifying certain guidance to ensure that U.S. generally accepted accounting principles (U.S. GAAP) and International Financial Reporting Standards (IFRS) have the same fair value meaning, measurements and disclosure requirements. The amended guidance will become effective for interim and annual periods beginning after December 15, 2011. The Company is evaluating the impact of the new guidance on its financial position, results of operations or cash flows upon adoption.
Presentation of Comprehensive Income
In June 2011, the FASB issued an amendment to ASC Topic 220, Comprehensive Income, allowing two alternatives for the presentation of comprehensive income, eliminating the option to present the components of comprehensive income (OCI) as a part of the statement of changes in stockholder's equity and requiring that reclassification adjustments from OCI to income be presented on the face of the financial statements. Upon adoption, the total of comprehensive income, including the components of net income and OCI, will be presented in either one statement or in two separate but consecutive statements. The amendment will become effective for interim and annual periods beginning after December 15, 2011, with early adoption permitted. Since the new guidance only amends presentation of comprehensive income, there will be no impact to the Company's financial position, results of operations or cash flows upon adoption.
3. | REGULATION |
As a result of NJNG being subject to cost-based regulation it is permitted to recover authorized operating expenses and earn a reasonable return on their utility investment based on BPU decisions and in accordance with accounting guidance applicable to regulated operations. The impact of the ratemaking process and decisions authorized by the BPU allows NJNG to capitalize or defer certain costs that are expected to be recovered from its customers through rates as regulatory assets and recognizes certain obligations representing probable future events as regulatory liabilities.
Regulatory assets included in the Unaudited Condensed Consolidated Balance Sheets are comprised of the following:
(Thousands) | June 30, 2011 | September 30, 2010 | ||||
Regulatory assets-current | ||||||
Underrecovered gas costs (1) | $ | 156 | $ | 36,485 | ||
Conservation Incentive Program (1) | 9,375 | 14,960 | ||||
Other (1) | — | 21 | ||||
Total current | $ | 9,531 | $ | 51,466 | ||
Regulatory assets-noncurrent | ||||||
Environmental remediation costs (Note 13) | ||||||
Expended, net of recoveries (2) | $ | 73,495 | $ | 75,707 | ||
Liability for future expenditures (3) | 201,600 | 201,600 | ||||
Deferred income and other taxes (1) | 15,010 | 13,860 | ||||
Derivatives, net (Note 4) (1) | 7,682 | 16,497 | ||||
Energy Efficiency Program (2) | 8,685 | 3,958 | ||||
New Jersey Clean Energy Program (2) | 21,448 | 30,935 | ||||
Pipeline Integrity Management (4) | 1,148 | 1,148 | ||||
Postemployment benefit costs (Note 10) (1) | 105,999 | 106,225 | ||||
Other (5) | 3,662 | 4,671 | ||||
Total noncurrent | $ | 438,729 | $ | 454,601 |
(1) | Recoverable, without interest. |
(2) | Recoverable, with interest. |
(3) | Recovery will be requested when actual expenditures are incurred (see Note 13. Commitments and Contingent Liabilities). |
(4) | Recoverable, subject to BPU review and approval in the next base rate case. |
(5) | Recoverable, with or without interest depending on the specific program. |
Page 9
New Jersey Resources Corporation
Part I
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Recovery of regulatory assets is subject to BPU approval. If there should be any changes in regulatory positions that indicate recovery is not probable, the related cost would be charged to income in the period of such determination.
Regulatory liabilities included in the Unaudited Condensed Consolidated Balance Sheets are comprised of the following:
(Thousands) | June 30, 2011 | September 30, 2010 | ||||
Regulatory liabilities-noncurrent | ||||||
Cost of removal obligation (1) | $ | 57,963 | $ | 57,648 | ||
Other (2) | 90 | — | ||||
Total noncurrent | $ | 58,053 | $ | 57,648 |
(1) | NJNG accrues and collects for cost of removal in rates. This liability represents collections in excess of actual expenditures. |
(2) | Refundable, with or without interest depending on the specific program. |
Recent regulatory filings and/or actions include the following:
• | In September 2010, the BPU provisionally approved the recovery of $12.1 million related to the Conservation Incentive Program (CIP) effective October 1, 2010, and a decrease to BGSS rates, effective September 16, 2010, both of which were finally approved in April 2011. On June 1, 2011, NJNG filed for a 9.1 percent BGSS price decrease for the average residential heat customer as a result of lower natural gas prices and natural gas purchasing strategies, and a change in the CIP rates. The proposed CIP rates result in an increase to all classes except residential heat, which represents a decrease. Pending BPU approval, the changes will go into effect October 1, 2011. |
• | On October 20, 2010, NJNG filed a petition with the BPU for approval of an extension to NJNG's Accelerated Energy Infrastructure Program (AIP II) for capital investments, in the amount of $52.2 million. On January 24, 2011, NJNG amended the amount of this petition to $60.2 million for capital investments to be made through October 31, 2012. NJNG requested approval from the BPU for the recovery of expenditures through base rates, which would include the Company's overall weighted cost of capital of 7.76 percent authorized in its last base rate case. On March 30, 2011, the BPU approved the amended AIP II filing. NJNG will submit filings requesting recovery of AIP II investment costs through base rates, which will include an overall weighted average cost of capital of 7.12 percent that includes a 10.3 percent return on equity. |
On June 1, 2011, NJNG filed for an increase in base rate cost recovery of $4.7 million annually, related to AIP I and AIP II infrastructure investments installed in NJNG's distribution and transmission systems, to be effective on October 1, 2011. An additional filing will be submitted in October 2012, requesting rate changes to be effective in January 1, 2013.
• | Effective November 1, 2010, the BPU approved the recovery of the USF program year budget and the recovery of deferred USF administrative costs. On June 30, 2011, NJNG filed for a 0.1 percent decrease in the annual recovery rate to be effective October 1, 2011. |
• | NJNG is eligible to receive financial incentives for reducing Basic Gas Supply Service (BGSS) costs through a series of margin-sharing programs that include off-system sales, capacity release, storage incentive and financial risk management (FRM) programs. On April 1, 2011, NJNG filed a petition with the BPU for approval of an extension of these incentive programs. On July 25, 2011, NJNG, the BPU and Rate Counsel executed a Stipulation to extend NJNG's margin-sharing incentive programs for four years through October 31, 2015, under the same terms of its previous agreement with respect to margin-sharing percentages. This agreement also permits the Company to annually propose a process to evaluate and discuss alternative incentive programs, should performance of the existing incentives or market conditions warrant re-evaluation. BPU approval is expected by September 30, 2011. |
• | On June 1, 2011, NJNG filed its annual Energy Efficiency (EE) Program filing with the BPU, which was subsequently amended to request that the current recovery rate remain the same. On July 15, 2011, NJNG filed a separate petition to extend its current EE Programs through December 31, 2012. |
• | On June 16, 2011, NJNG submitted a filing with the BPU seeking authority to invest up to $15 million to build compressed natural gas vehicle refueling stations in Monmouth, Ocean and Morris counties. If approved, NJNG would begin construction of the stations no later than December 31, 2012. NJNG would submit a cost recovery filing to the BPU in October 2012, requesting a base rate change to be effective early in 2013. Proceeds from the delivery of the associated natural gas, along with any available federal and state incentives, will be credited back to customers to help offset the cost of this investment. |
Page 10
New Jersey Resources Corporation
Part I
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
4. | DERIVATIVE INSTRUMENTS |
The Company and certain of its subsidiaries are subject to commodity price risk due to fluctuations in the market price of natural gas. To manage this risk, the Company and certain of its subsidiaries enter into a variety of derivative instruments including, but not limited to, futures contracts, physical forward contracts, financial options and swaps to economically hedge the commodity price risk associated with its existing and anticipated commitments to purchase and sell natural gas. In addition, the Company may utilize foreign currency derivatives as cash flow hedges of Canadian dollar denominated gas purchases. These contracts, with a few exceptions as described below, are accounted for as derivatives. Accordingly, all of the financial and certain of the Company's physical derivative instruments are recorded at fair value in the Unaudited Condensed Consolidated Balance Sheets. For a more detailed discussion of the Company's fair value measurement policies and level disclosures associated with the NJR's derivative instruments (see Note 5. Fair Value).
Since the Company chooses not to designate its financial commodity and physical forward commodity derivatives as accounting hedges, changes in the fair value of these derivative instruments are concurrently recorded as a component of gas purchases or operating revenues, as appropriate for NJRES, in the Unaudited Condensed Consolidated Statements of Operations as unrealized gains or losses. For NJRES at settlement, realized gains and losses on all financial derivative instruments are recognized as a component of gas purchases and realized gains and losses on all physical derivatives follow the presentation of the related unrealized gains and losses as a component of either gas purchases or operating revenues.
NJRES also enters into natural gas transactions in Canada and, consequently, is exposed to fluctuations in the value of Canadian currency relative to the US dollar. NJRES utilizes foreign currency derivatives to lock in the currency translation rate associated with natural gas transactions denominated in Canadian currency. The derivatives may include currency forwards, futures, or swaps and are accounted for as derivatives. These derivatives are being used to hedge future forecasted cash payments associated with transportation and storage contracts. The Company has designated these foreign currency derivatives as cash flow hedges of that exposure, and expects the hedge relationship to be highly effective throughout the term. Since NJRES designates its foreign exchange contracts as cash flow hedges, changes in fair value are recorded in other comprehensive income (OCI). When the foreign exchange contracts are settled, realized gains and losses are recognized in gas purchases in the Unaudited Condensed Consolidated Statements of Operations.
Realized and unrealized gains and losses related to NJR Energy's financial derivatives, which have expired, were recorded as a component of operating revenues during fiscal 2010.
Changes in fair value of NJNG's derivative instruments, however, are recorded as a component of regulatory assets or liabilities in the Unaudited Condensed Consolidated Balance Sheets, as NJNG has received regulatory approval to defer and to recover these amounts through future BGSS rates as an increase or decrease to the cost of natural gas in NJNG's tariff.
As a result of NJRES entering into transactions to borrow gas, commonly referred to as “park and loans,” an embedded derivative is created related to potential differences between the fair value of the amount borrowed and the fair value of the amount that may ultimately be repaid, based on changes in forward natural gas prices during the contract term. This embedded derivative is accounted for as a forward sale in the month in which the repayment of the borrowed gas is expected to occur, and is considered a derivative transaction that is recorded at fair value on the balance sheet, with changes in value recognized in current period earnings.
The Company elects normal purchase/normal sale accounting treatment on all physical commodity contracts at NJNG. These contracts are accounted for on an accrual basis. Accordingly, gains (losses) are recognized in earnings when the contract settles and the natural gas is delivered.
Page 11
New Jersey Resources Corporation
Part I
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Fair Value of Derivatives
The following table reflects the fair value of NJR's derivative assets and liabilities recognized in the Unaudited Condensed Consolidated Balance Sheets as of:
Fair Value | |||||||||||||||||
June 30, 2011 | September 30, 2010 | ||||||||||||||||
(Thousands) | Balance Sheet Location | Asset Derivatives | Liability Derivatives | Asset Derivatives | Liability Derivatives | ||||||||||||
Derivatives designated as hedging instruments: | |||||||||||||||||
NJRES: | |||||||||||||||||
Foreign exchange contracts | Derivatives - current | $ | 107 | $ | — | $ | 15 | $ | — | ||||||||
Derivatives - noncurrent | 82 | — | 10 | — | |||||||||||||
Fair value of derivatives designated as hedging instruments | $ | 189 | $ | — | $ | 25 | $ | — | |||||||||
Derivatives not designated as hedging instruments: | |||||||||||||||||
NJNG: | |||||||||||||||||
Financial commodity contracts | Derivatives - current | $ | 5,338 | $ | 13,020 | $ | 9,952 | $ | 24,724 | ||||||||
Derivatives - noncurrent | — | — | — | 1,725 | |||||||||||||
NJRES: | |||||||||||||||||
Physical forward commodity contracts | Derivatives - current | 19,439 | 5,219 | 18,566 | 5,879 | ||||||||||||
Derivatives - noncurrent | 3,734 | 989 | 5,482 | 179 | |||||||||||||
Financial commodity contracts | Derivatives - current | 34,134 | 26,899 | 106,653 | 47,844 | ||||||||||||
Derivatives - noncurrent | 1,265 | 3,040 | 2,465 | 3,736 | |||||||||||||
Fair value of derivatives not designated as hedging instruments | $ | 63,910 | $ | 49,167 | $ | 143,118 | $ | 84,087 | |||||||||
Total fair value of derivatives | $ | 64,099 | $ | 49,167 | $ | 143,143 | $ | 84,087 |
At June 30, 2011, the notional amount of the foreign currency transactions was approximately $2.6 million, and ineffectiveness in the hedge relationship is immaterial to the financial results of NJR.
NJRES utilizes financial derivatives to economically hedge the gross margin associated with the purchase of physical gas for injection into storage and the subsequent sale of physical gas at a later date. The gains (losses) on the financial transactions that are economic hedges of the cost of the purchased gas are recognized prior to the gains (losses) on the physical transaction, which are recognized in earnings when the natural gas is sold. Therefore, mismatches between the timing of the recognition of realized gains or losses on the financial derivative instruments and gains (losses) associated with the actual sale of the natural gas that is being economically hedged along with fair value changes in derivative instruments creates volatility in the results of NJRES, although the Company's intended economic results relating to the entire transaction are unaffected.
The following table reflects the effect of derivative instruments on the Unaudited Condensed Consolidated Statements of Operations as of:
(Thousands) | Location of gain (loss) recognized in income on derivatives | Amount of gain (loss) recognized in income on derivatives | |||||||||||||
Three Months Ended | Nine Months Ended | ||||||||||||||
June 30, | June 30, | ||||||||||||||
Derivatives not designated as hedging instruments: | 2011 | 2010 | 2011 | 2010 | |||||||||||
NJRES: | |||||||||||||||
Physical commodity contracts | Operating revenues | $ | 5,044 | $ | 12,890 | $ | 29,881 | $ | 35,564 | ||||||
Physical commodity contracts | Gas purchases | 4,639 | (12,110 | ) | (1,467 | ) | (11,956 | ) | |||||||
Financial commodity contracts | Gas purchases | 8,703 | (11,449 | ) | (19,072 | ) | 53,668 | ||||||||
Subtotal NJRES | 18,386 | (10,669 | ) | 9,342 | 77,276 | ||||||||||
NJR Energy: | |||||||||||||||
Financial commodity contracts | Operating revenues | — | 421 | — | (6,085 | ) | |||||||||
Total NJRES and NJR Energy unrealized and realized gains (losses) | $ | 18,386 | $ | (10,248 | ) | $ | 9,342 | $ | 71,191 |
Page 12
New Jersey Resources Corporation
Part I
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Not included in the previous table, are (losses) gains associated with NJNG's financial derivatives that totaled $(2.1) million and $12.9 million for the three months ended June 30, 2011 and 2010, respectively and $(7) million and $(27) million for the nine months ended June 30, 2011 and 2010, respectively. These derivatives are part of its 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 NJNG's financial derivatives are deferred in regulatory assets or liabilities and there is no impact to earnings.
As noted above, NJRES designates its foreign exchange contracts as cash flow hedges, therefore, changes in fair value are recorded in OCI and, upon settlement of the contracts, realized gains and losses are reclassified from OCI to gas purchases in the Unaudited Condensed Consolidated Statements of Operations. The following tables reflect the effect of derivative instruments designated as cash flow hedges on OCI:
(Thousands) | Amount of Gain or (Loss) Recognized in OCI on Derivatives (Effective Portion) | Amount of Gain or (Loss) Reclassified from OCI (Effective Portion) | Amount of Gain or (Loss) Recognized on Derivative (Ineffective Portion and Amount Excluded from Effectiveness Testing) | |||||||||||||||
Three Months Ended | Three Months Ended | Three Months Ended | ||||||||||||||||
June 30, | June 30, | June 30, | ||||||||||||||||
Derivatives in cash flow hedging relationships: | 2011 | 2010 (1) | 2011 | 2010 (1) | 2011 | 2010 (1) | ||||||||||||
Foreign currency contracts | $ | 3 | $ | (144 | ) | $ | 32 | $ | 5 | $ | — | $ | — | |||||
Total | $ | 3 | $ | (144 | ) | $ | 32 | $ | 5 | $ | — | $ | — |
(1) | NJRES began hedging its foreign currency exposure in May 2010, therefore, amounts for the three months ended June 30, 2010 only include gains and losses for May 2010 through June 2010 and is not comparative to the three months ended June 30, 2011. |
(Thousands) | Amount of Gain or (Loss) Recognized in OCI on Derivatives (Effective Portion) (1) | Amount of Gain or (Loss) Reclassified from OCI into Income (Effective Portion) | Amount of Gain or (Loss) Recognized on Derivative (Ineffective Portion and Amount Excluded from Effectiveness Testing) | |||||||||||||||
Nine Months Ended | Nine Months Ended | Nine Months Ended | ||||||||||||||||
June 30, | June 30, | June 30, | ||||||||||||||||
Derivatives in cash flow hedging relationships: | 2011 | 2010 (2) | 2011 | 2010 (2) | 2011 | 2010 (2) | ||||||||||||
Foreign currency contracts | $ | 164 | $ | (144 | ) | $ | 91 | $ | 5 | $ | — | $ | — | |||||
Total | $ | 164 | $ | (144 | ) | $ | 91 | $ | 5 | $ | — | $ | — |
(1) | The settlement of foreign currency transactions over the next 12 months is expected to result in the reclassification of $107,000 from OCI into earnings. The maximum tenor is April 2013. |
(2) | NJRES began hedging its foreign currency exposure in May 2010, therefore, amounts for the nine months ended June 30, 2010 only include gains and losses for May 2010 through June 2010 and is not comparative to the nine months ended June 30, 2011. |
NJNG and NJRES had the following outstanding long (short) derivatives as of:
Volume (Bcf) | ||||||
June 30, 2011 | September 30, 2010 | |||||
NJNG | Futures | (2.5 | ) | 20.8 | ||
Swaps | 10.7 | (8.7 | ) | |||
NJRES | Futures | (13.6 | ) | (13.0 | ) | |
Swaps | (16.1 | ) | (7.3 | ) | ||
Options | — | 0.6 | ||||
Physical | 72.1 | 36.1 |
Page 13
New Jersey Resources Corporation
Part I
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Broker Margin
Generally, exchange-traded futures contracts require posted collateral, referred to as margin, usually in the form of cash. The amount of margin required is comprised of a fixed initial amount based on the contract and a variable amount based on market price movements from the initial trade price. The Company maintains broker margin accounts for NJNG and NJRES. The balances by company are as follows:
(Thousands) | Balance Sheet Location | June 30, 2011 | September 30, 2010 | ||||
NJNG broker margin deposit | Broker margin - Current assets | $ | 13,034 | $ | 19,241 | ||
NJRES broker margin deposit | Broker margin - Current assets (liabilities) | $ | 14,292 | $ | (28,459 | ) |
Wholesale Credit Risk
NJNG and NJRES are exposed to credit risk as a result of their wholesale marketing activities. As a result of the inherent volatility in the prices of natural gas commodities and derivatives, the market value of contractual positions with individual counterparties could exceed established credit limits or collateral provided by those counterparties. If a counterparty failed to perform the obligations under its contract (e.g., failed to deliver or pay for natural gas), then the Company could sustain a loss.
NJR monitors and manages the credit risk of its wholesale marketing operations through credit policies and procedures that management believes reduce overall credit risk. These policies include a review and evaluation of current and prospective counterparties' financial statements and/or credit ratings, daily monitoring of counterparties' credit limits and exposure, daily communication with traders regarding credit status and the use of credit mitigation measures, such as collateral requirements and netting agreements. Examples of collateral include letters of credit and cash received for either prepayment or margin deposit. Collateral may be requested due to NJR's election not to extend credit or because exposure exceeds defined thresholds. Most of NJR's wholesale marketing contracts contain standard netting provisions. These contracts include those governed by the International Swaps and Derivatives Association (ISDA) and the North American Energy Standards Board (NAESB). The netting provisions refer to payment netting, whereby receivables and payables with the same counterparty are offset and the resulting net amount is paid to the party to which it is due.
The following is a summary of gross credit exposures grouped by investment and noninvestment grade counterparties, as of June 30, 2011. Internally-rated exposure applies to counterparties that are not rated by Standard & Poor's (S&P) or Moody's Investors Service, Inc. (Moody's). In these cases, the company's or guarantor's financial statements are reviewed, and similar methodologies and ratios used by S&P and/or Moody's are applied to arrive at a substitute rating. Gross credit exposure is defined as the unrealized fair value of physical and financial derivative commodity contracts plus any outstanding wholesale receivable for the value of natural gas delivered for which payment has not yet been received. The amounts presented below have not been reduced by any collateral received or netting and exclude accounts receivable for NJNG retail natural gas sales and services.
(Thousands) | Gross Credit Exposure | ||||
Investment grade | $ | 164,598 | |||
Noninvestment grade | 10,567 | ||||
Internally rated investment grade | 47,772 | ||||
Internally rated noninvestment grade | 11,327 | ||||
Total | $ | 234,264 |
Conversely, certain of NJNG's and NJRES' derivative instruments are linked to agreements containing provisions that would require cash collateral payments from the Company if certain events occur. These provisions vary based upon the terms in individual counterparty agreements and can result in cash payments if NJNG's credit rating were to fall below its current level. NJNG's credit rating, with respect to S&P, reflects the overall corporate credit profile of NJR. Specifically, most, but not all, of these additional payments will be triggered if NJNG's debt is downgraded by the major credit agencies, regardless of investment grade status. As well, some of these agreements include threshold amounts that would result in additional collateral payments if the values of derivative liabilities were to exceed the maximum values provided for in relevant counterparty agreements. Other provisions include payment features that are not specifically linked to ratings, but are based on certain financial metrics.
Page 14
New Jersey Resources Corporation
Part I
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Collateral amounts associated with any of these conditions, are determined based on a sliding scale and are contingent upon the degree to which the Company's credit rating and/or financial metrics deteriorate, and the extent to which liability amounts exceed applicable threshold limits. The aggregate fair value of all derivative instruments with credit-risk-related contingent features that were in a liability position on June 30, 2011 and September 30, 2010, is $1.3 million and $7.4 million, respectively, for which the Company had not posted any collateral. If all the thresholds related to the credit-risk-related contingent features underlying these agreements had been invoked on June 30, 2011 and September 30, 2010, the Company would have been required to post an additional $200,000 and $5.5 million, respectively, to its counterparties. These amounts differ from the respective net derivative liabilities reflected in the Unaudited Condensed Consolidated Balance Sheets because the agreements also include clauses, commonly known as “Rights of Offset,” that would permit the Company to offset its derivative assets against its derivative liabilities for determining additional collateral to be posted.
5. | FAIR VALUE |
Fair Value of Assets and Liabilities
The fair value of cash and temporary investments, commercial paper and borrowings under revolving credit facilities are estimated to equal their carrying amounts due to the short maturity of those instruments. The estimated fair value of long-term debt, including current maturities, is based on quoted market prices for similar issues and is as follows:
(Thousands) | June 30, 2011 | September 30, 2010 | ||||
Carrying value | $ | 440,424 | $ | 460,182 | ||
Fair market value | $ | 466,497 | $ | 495,035 |
Fair Value Hierarchy
NJR applies fair value measurement guidance to its financial assets and liabilities, as appropriate, which include financial derivatives and physical commodity contracts qualifying as derivatives, available for sale securities and other financial assets and liabilities. In addition, authoritative accounting literature prescribes the use of a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value based on the source of the data used to develop the price inputs. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities and the lowest priority to inputs that are based on unobservable market data and include the following:
Level 1 | Unadjusted quoted prices for identical assets or liabilities in active markets; NJR's Level 1 assets and liabilities include exchange traded financial derivative contracts, listed equities, and money market funds. |
Level 2 | Price data, which includes both commodity and basis price data other than Level 1 quotes, that is observed either directly or indirectly from publications or pricing services; NJR's Level 2 assets and liabilities include over-the-counter physical forward commodity contracts and swap contracts or derivatives that are initially valued using observable quotes and are subsequently adjusted to include time value, credit risk or estimated transport pricing components for which no basis price is available. These additional adjustments are not considered to be significant to the ultimate recognized values. |
Level 3 | Inputs derived from a significant amount of unobservable market data; these include NJR's best estimate of fair value and are derived primarily through the use of internal valuation methodologies. |
NJNG's and NJRES' financial derivatives portfolios consist mainly of futures, options and swaps. NJR primarily uses the market approach and its policy is to use actively quoted market prices when available. The principal market for its derivative transactions is the natural gas wholesale market, therefore, the primary source for its price inputs is the New York Mercantile (NYMEX) exchange. NJRES also uses Natural Gas Exchange (NGX) for Canadian delivery points and Platts and NYMEX ClearPort for certain over-the-counter physical forward commodity contracts. However, NJRES also engages in transactions that result in transporting natural gas to delivery points for which there is no actively quoted market price. In most instances, the cost to transport to the final delivery location is not significant to the overall valuation. If required, NJRES' policy is to use the best information available to determine fair value based on internal pricing models, which would include estimates extrapolated from broker quotes or pricing services.
Page 15
New Jersey Resources Corporation
Part I
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NJR also has available for sale securities and other financial assets that include listed equities, mutual funds and money market funds for which there are active exchange quotes available.
When NJR determines fair values, measurements are adjusted, as needed, for credit risk associated with its counterparties, as well as its own credit risk. NJR determines these adjustments by using historical default probabilities that correspond to the applicable Standard and Poor's issuer ratings, while also taking into consideration collateral and netting arrangements that serve to mitigate risk.
Assets and liabilities measured at fair value on a recurring basis are summarized as follows:
Quoted Prices in Active Markets for Identical Assets | Significant Other Observable Inputs | Significant Unobservable Inputs | ||||||||||||||||
(Thousands) | (Level 1) | (Level 2) | (Level 3) | Total | ||||||||||||||
As of June 30, 2011: | ||||||||||||||||||
Assets: | ||||||||||||||||||
Physical forward commodity contracts | $ | — | $ | 23,173 | $ | — | $ | 23,173 | ||||||||||
Financial derivative contracts - natural gas | 7,208 | 33,529 | — | 40,737 | ||||||||||||||
Financial commodity contracts - foreign exchange | — | 189 | — | 189 | ||||||||||||||
Available for sale equity securities - energy industry (1) | 11,296 | — | — | 11,296 | ||||||||||||||
Other | 28,685 | — | — | 28,685 | ||||||||||||||
Total assets at fair value | $ | 47,189 | $ | 56,891 | $ | — | $ | 104,080 | ||||||||||
Liabilities: | ||||||||||||||||||
Physical forward commodity contracts | $ | — | $ | 6,208 | $ | — | $ | 6,208 | ||||||||||
Financial commodity contracts - natural gas | 19,119 | 23,840 | — | 42,959 | ||||||||||||||
Other | 647 | — | — | 647 | ||||||||||||||
Total liabilities at fair value | $ | 19,766 | $ | 30,048 | $ | — | $ | 49,814 | ||||||||||
As of September 30, 2010: | ||||||||||||||||||
Assets: | ||||||||||||||||||
Physical forward commodity contracts | $ | — | $ | 24,048 | $ | — | $ | 24,048 | ||||||||||
Financial derivative contracts - natural gas | 58,824 | 60,246 | — | 119,070 | ||||||||||||||
Financial commodity contracts - foreign exchange | — | 25 | — | 25 | ||||||||||||||
Available for sale equity securities - energy industry (1) | 10,290 | — | — | 10,290 | ||||||||||||||
Other | 947 | — | — | 947 | ||||||||||||||
Total assets at fair value | $ | 70,061 | $ | 84,319 | $ | — | $ | 154,380 | ||||||||||
Liabilities: | ||||||||||||||||||
Physical forward commodity contracts | $ | — | $ | 6,058 | $ | — | $ | 6,058 | ||||||||||
Financial derivative contracts - natural gas | 38,497 | 39,532 | — | 78,029 | ||||||||||||||
Other | 936 | — | — | 936 | ||||||||||||||
Total liabilities at fair value | $ | 39,433 | $ | 45,590 | $ | — | $ | 85,023 |
(1) | Included in Investments in equity investees in the Unaudited Condensed Consolidated Balance Sheets. |
Page 16
New Jersey Resources Corporation
Part I
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
6. | INVESTMENTS IN EQUITY INVESTEES |
NJR's Investments in equity investees include the following investments as of:
(Thousands) | June 30, 2011 | September 30, 2010 | ||||
Steckman Ridge | $ | 136,029 | $ | 134,359 | ||
Iroquois | 25,652 | 24,585 | ||||
Other | 11,296 | 10,290 | ||||
Total | $ | 172,977 | $ | 169,234 |
NJR uses the equity method of accounting for its investments in Steckman Ridge and Iroquois. Earnings or losses from equity method investments are included in Equity in earnings of affiliates in the Unaudited Condensed Consolidated Statements of Operations.
Other consists of an investment in equity securities of a publicly traded energy company and is accounted for as available for sale securities, with any change in the value of such investment recorded in OCI.
7. | EARNINGS PER SHARE |
The following table presents the calculation of the Company's basic and diluted earnings per share for:
Three Months Ended | Nine Months Ended | |||||||||||
June 30, | June 30, | |||||||||||
(Thousands, except per share amounts) | 2011 | 2010 | 2011 | 2010 | ||||||||
Net income (loss), as reported | $ | 20,374 | $ | (10,177 | ) | $ | 108,810 | $ | 115,942 | |||
Basic earnings per share | ||||||||||||
Weighted average shares of common stock outstanding-basic | 41,381 | 41,239 | 41,338 | 41,424 | ||||||||
Basic earnings per common share | $0.49 | $(0.25) | $2.63 | $2.80 | ||||||||
Diluted earnings per share | ||||||||||||
Weighted average shares of common stock outstanding-basic | 41,381 | 41,239 | 41,338 | 41,424 | ||||||||
Incremental shares (1) | 216 | — | 213 | 279 | ||||||||
Weighted average shares of common stock outstanding-diluted | 41,597 | 41,239 | 41,551 | 41,703 | ||||||||
Diluted earnings per common share (2) | $0.49 | $(0.25) | $2.62 | $2.78 |
(1) | Incremental shares consist of stock options, stock awards and performance units. |
(2) | There were no anti-dilutive shares excluded from the calculation of diluted earnings per share for the three months ended June 30, 2011 and nine months ended June 30, 2011, and 2010. Since there was a net loss for the three months ended June 30, 2010, incremental shares were not included in the computation of diluted loss per common share, as their effect would have been anti-dilutive. |
8. | DEBT |
A summary of NJR's and NJNG's long-term debt are as follows:
(Thousands) | June 30, 2011 | September 30, 2010 | |||||
NJR | $ | 50,000 | $ | 50,000 | |||
NJNG (1) | 329,845 | 349,845 | |||||
Total | $ | 379,845 | $ | 399,845 |
(1) | Long-term debt excludes lease obligations of $60.6 million and $60.3 million at June 30, 2011 and September 30, 2010, respectively. |
Page 17
New Jersey Resources Corporation
Part I
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
A summary of NJR's and NJNG's debt shelf and credit facilities are as follows:
(Thousands) | June 30, 2011 | September 30, 2010 | |||||
NJR | |||||||
Debt shelf facilities (1) | $ | 175,000 | $ | — | |||
Bank credit facilities (2) | $ | 325,000 | $ | 325,000 | |||
Amount outstanding at end of period | |||||||
Notes payable to banks | $ | 138,000 | $ | 140,600 | |||
Weighted average interest rate at end of period | |||||||
Notes payable to banks | 0.51 | % | 0.64 | % | |||
NJNG | |||||||
Bank credit facilities (2) | $ | 200,000 | $ | 200,000 | |||
Amount outstanding at end of period | |||||||
Commercial paper | $ | — | $ | 7,000 | |||
Weighted average interest rate at end of period | |||||||
Commercial paper | — | % | 0.26 | % |
(1) | Uncommitted, long-term debt shelf facilities, which require no commitment fees on the unused amounts. |
(2) | Committed credit facilities, which require commitment fees on the unused amounts. |
NJR
NJR has a $325 million unsecured committed credit facility expiring in December 2012. As of June 30, 2011, NJR had $138 million in borrowings outstanding under the facility.
On January 11, 2011, NJR entered into an agreement for an additional $50 million unsecured committed credit line, which was terminated by NJR on February 22, 2011. The additional credit line, was put in place primarily to provide additional working capital to NJRES to meet any potential margin calls that could have arisen in NJRES' normal course of business.
NJR entered into two new unsecured, uncommitted private placement debt shelf note agreements in the third quarter of fiscal 2011. The first agreement was entered into on May 12, 2011, in the amount of $100 million, and expires on May 10, 2013. The second agreement became effective on June 30, 2011, in the amount of $75 million, and expires on June 30, 2014. Notes issued under these agreements will be guaranteed by certain unregulated subsidiaries of the Company. The additional credit lines will be used for general corporate purposes, including working capital and capital expenditures. As of June 30, 2011, NJR had no borrowings outstanding under these agreements.
As of June 30, 2011, NJR has five letters of credit outstanding totaling $8.4 million. Three of the letters of credit, which total $7.1 million, are on behalf of NJRES. The other two letters of credit are on behalf of CR&R and NJRCEV in the amount of $675,000 and $711,000, respectively. These letters of credit reduce the amount available under NJR's committed credit facility by the same amount. NJR does not anticipate that these letters of credit will be drawn upon by the counterparties, and they will be renewed as necessary.
Two of NJRES' letters of credit are used to secure the purchase and/or sale of natural gas; one expires on December 31, 2011, and the other expires on February 1, 2012. The third NJRES letter of credit is used for margin requirements for natural gas transactions and expires on December 31, 2011. CR&R's letter of credit is in place to support development activities and expires on December 3, 2011. NJRCEV's letter of credit is in place to secure construction of a ground-mounted solar project and expires on June 22, 2012.
NJNG
NJNG has a $200 million revolving unsecured committed credit facility, which expires in December 2012. The credit facility is used to support NJNG's commercial paper program and provides for the issuance of letters of credit. As of June 30, 2011, NJNG had no borrowings outstanding under the facility.
On October 1, 2010, upon maturity, NJNG redeemed its $20 million, 6.88 percent Series CC First Mortgage bonds.
Page 18
New Jersey Resources Corporation
Part I
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NJNG received $5.9 million and $4.9 million in December 2010 and 2009, respectively, in connection with the sale-leaseback of its natural gas meters. This sale-leaseback program is expected to be continued on an annual basis.
Neither NJNG nor the results of its operations are obligated or pledged to support the NJR credit facility or NJR private placement debt shelf facilities.
9. | STOCK-BASED COMPENSATION |
On November 17, 2010, the Company granted 56,325 performance shares, which are market condition awards that vest on September 30, 2013, subject to certain conditions. Also on November 17, 2010, the company granted 36,614 restricted shares, which vest in three equal annual installments, the first occurring on October 15, 2011, and 25,535 restricted shares, all scheduled to vest on November 17, 2013. As of June 30, 2011, 1,970,094 and 71,962 shares remain available for future issuance to employees and directors, respectively.
During the nine months ended June 30, 2011, included in operation and maintenance expense is $2.1 million related to stock-based compensation compared with $2 million during the nine months ended June 30, 2010. As of June 30, 2011, there remains $5.2 million of deferred compensation related to unvested restricted and performance shares that is expected to be recognized over the next two and a half years.
10. | EMPLOYEE BENEFIT PLANS |
Pension and Other Postemployment Benefit Plans (OPEB)
The components of the net periodic cost for pension benefits, including NJR's Pension Equalization Plan, and OPEB costs (principally health care and life insurance) for employees and covered dependents are as follows:
Pension | OPEB | |||||||||||||||||||||||
Three Months Ended | Nine Months Ended | Three Months Ended | Nine Months Ended | |||||||||||||||||||||
June 30, | June 30, | June 30, | June 30, | |||||||||||||||||||||
(Thousands) | 2011 | 2010 | 2011 | 2010 | 2011 | 2010 | 2011 | 2010 | ||||||||||||||||
Service cost | $ | 1,194 | $ | 992 | $ | 3,582 | $ | 2,976 | $ | 836 | $ | 704 | $ | 2,508 | $ | 2,112 | ||||||||
Interest cost | 2,094 | 2,049 | 6,283 | 6,147 | 1,211 | 1,204 | 3,634 | 3,612 | ||||||||||||||||
Expected return on plan assets | (2,873 | ) | (2,577 | ) | (8,618 | ) | (7,731 | ) | (618 | ) | (485 | ) | (1,854 | ) | (1,455 | ) | ||||||||
Recognized actuarial loss | 987 | 681 | 2,960 | 2,043 | 653 | 570 | 1,959 | 1,710 | ||||||||||||||||
Prior service cost amortization | 12 | 14 | 36 | 42 | 19 | 19 | 57 | 57 | ||||||||||||||||
Recognized net initial obligation | — | — | — | — | 89 | 89 | 267 | 267 | ||||||||||||||||
Net periodic benefit cost | $ | 1,414 | $ | 1,159 | $ | 4,243 | $ | 3,477 | $ | 2,190 | $ | 2,101 | $ | 6,571 | $ | 6,303 |
The Company does not expect to be required to make additional contributions to fund the pension plans over the next three fiscal years based on current actuarial assumptions; however, funding requirements are uncertain and can depend significantly on changes in actuarial assumptions, returns on plan assets and changes in the demographics of eligible employees and covered dependents. In addition, as in the past, the Company may elect to make contributions in excess of the minimum required amount to the plans. NJR made a discretionary contribution of $4.9 million to the pension plans in October 2010. It is anticipated that the annual funding level to the OPEB plans will range from $5.5 million to $6.6 million annually over the next five years. Additional contributions may be made based on market conditions and various assumptions.
Page 19
New Jersey Resources Corporation
Part I
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
11. | ASSET RETIREMENT OBLIGATIONS (ARO) |
NJR recognizes AROs related to the costs associated with cutting and capping its main and service gas distribution pipelines of NJNG, which are required by New Jersey law when taking such gas distribution pipeline out of service.
The following is an analysis of the change in the ARO liability:
(Thousands) | June 30, 2011 | September 30, 2010 | |||||
Balance at October 1 | $ | 26,009 | $ | 25,097 | |||
Accretion | 1,242 | 1,572 | |||||
Additions | — | 149 | |||||
Retirements | (711 | ) | (809 | ) | |||
Balance at period end | $ | 26,540 | $ | 26,009 |
Accretion amounts are not reflected as an expense on NJR's Unaudited Condensed Consolidated Statements of Operations, but rather are deferred as a regulatory asset and netted against NJNG's regulatory liabilities, for presentation purposes, on the Unaudited Condensed Consolidated Balance Sheet.
12. | INCOME TAXES |
NJR evaluates its tax positions to determine the appropriate accounting and recognition of potential future obligations associated with unrecognized tax benefits. As of June 30, 2011, the Company believes, based on its analysis, that there is no need to recognize any liabilities associated with uncertain tax positions.
NJRES has amended its New Jersey State Income Tax returns for the periods ended September 30, 2004, 2005, 2006 and 2007, requesting refunds related to a dispute over certain rules surrounding a company's ability to apportion income away from the state. Discussions between NJR and the State of New Jersey on the interpretation of the apportionment rules and relevant case law are substantially complete and the State has indicated that they will agree to a refund of approximately $4.3 million. Accordingly, in the three months ended June 30, 2011, NJRES recognized a $4.3 million state tax benefit. After fees and federal income taxes, the net impact is $2.4 million, or $0.06 per share.
The effective tax rates for the nine months ended June 30, 2011 and 2010, are 30.9 percent and 35 percent, respectively. The decrease in the rate is due primarily to federal investment tax credits (ITC) generated by NJRCEV's and NJRHS' solar investments placed into service as of June 30, 2011, and solar investments forecasted to be completed before the end of the fiscal year.
To calculate the estimated annual effective tax rate, NJR considers projects that are probable of being completed and available for use during the current fiscal year based on the best information available at each reporting period. The estimate includes an assessment of various factors, such as board of director approval, status of contractual agreements, permitting and interconnection. Adjustments to the effective tax rate and management's estimates will occur as information and assumptions change. For a more detailed discussion of risks associated with the effective tax rate, see Part II, Item 1A, Risk Factors.
13. | COMMITMENTS AND CONTINGENT LIABILITIES |
Cash Commitments
NJNG has entered into long-term contracts, expiring at various dates through October 2023, for the supply, storage and delivery of natural gas. These contracts include current annual fixed charges of approximately $105 million at current contract rates and volumes, which are recoverable through BGSS.
For the purpose of securing adequate storage and pipeline capacity, NJRES enters into storage and pipeline capacity contracts, which require the payment of certain demand charges by NJRES in order to maintain the ability to access such natural gas storage or pipeline capacity, during a fixed time period, which generally ranges from one to five years. Demand charges are based on established rates as regulated by the FERC. These demand charges represent commitments to pay storage providers or pipeline companies for the right to store and transport natural gas utilizing their respective assets.
Page 20
New Jersey Resources Corporation
Part I
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Commitments as of June 30, 2011, for natural gas purchases and future demand fees for the next five fiscal year periods are as follows:
(Thousands) | 2011 | 2012 | 2013 | 2014 | 2015 | Thereafter | ||||||||||||
NJRES: | ||||||||||||||||||
Natural gas purchases | $ | 268,965 | $ | 347,341 | $ | 69,619 | $ | — | $ | — | $ | — | ||||||
Storage demand fees | 10,046 | 31,140 | 17,399 | 11,494 | 7,207 | 11,924 | ||||||||||||
Pipeline demand fees | 12,842 | 42,859 | 21,550 | 8,680 | 7,195 | 21,432 | ||||||||||||
Sub-total NJRES | $ | 291,853 | $ | 421,340 | $ | 108,568 | $ | 20,174 | $ | 14,402 | $ | 33,356 | ||||||
NJNG: | ||||||||||||||||||
Natural gas purchases | $ | 40,809 | $ | 6,928 | $ | — | $ | — | $ | — | $ | — | ||||||
Storage demand fees | 7,804 | 31,208 | 29,920 | 24,153 | 14,999 | 44,340 | ||||||||||||
Pipeline demand fees | 16,309 | 76,809 | 76,966 | 71,821 | 35,182 | 228,661 | ||||||||||||
Sub-total NJNG | $ | 64,922 | $ | 114,945 | $ | 106,886 | $ | 95,974 | $ | 50,181 | $ | 273,001 | ||||||
Total (1) | $ | 356,775 | $ | 536,285 | $ | 215,454 | $ | 116,148 | $ | 64,583 | $ | 306,357 |
(1) Does not include amounts related to intercompany asset management agreements between NJRES and NJNG.
Costs for storage and pipeline demand fees, included as a component of gas purchases on the Unaudited Condensed Consolidated Statements of Operations, are as follows:
Three Months Ended | Nine Months Ended | |||||||||||
June 30, | June 30, | |||||||||||
(Millions) | 2011 | 2010 | 2011 | 2010 | ||||||||
NJRES | $ | 25.8 | $ | 22.6 | $ | 84.9 | $ | 82.4 | ||||
NJNG | 24.1 | 25.3 | 75.0 | 73.6 | ||||||||
Total | $ | 49.9 | $ | 47.9 | $ | 159.9 | $ | 156.0 |
NJNG's capital expenditures consist primarily of its construction program to support customer growth, maintenance of its distribution system and replacement needed under pipeline safety regulations. Expenditures are estimated at $108.2 million and $116.1 million for fiscal 2011 and 2012, respectively. As of June 30, 2011, approximately $76.1 million has been incurred on capital expenditures in fiscal 2011 including accruals. The expected expenditures for fiscal 2011 include an estimate of $26 million related to AIP I construction costs and $11 million related to AIP II. As of June 30, 2011, NJNG has incurred $24.9 million related to the AIP I programs and $789,000 related to AIP II programs during fiscal 2011.
The Company has entered into various agreements to install solar equipment involving both residential and commercial projects. Total solar-related capital expenditures during the nine months ended June 30, 2011 were $19.5 million, including $2 million for land. The Company currently estimates solar-related capital expenditures of between $70 and $80 million in fiscal 2011, of which $77.6 million has been either committed or spent. Capital expenditures in fiscal 2012 are expected to be $65.6 million. These investments are subject to a variety of factors, such as timing of construction schedules, the permitting and regulatory process, and any delays related to electric grid interconnection, which may affect our ability to commence operations at these projects on a timely basis or, at all.
As of June 30, 2011, the Company's future minimum lease payments under various operating leases will not be more than $2.1 million annually for the next five years and $1.3 million in the aggregate for all years thereafter.
Guarantees
As of June 30, 2011, there were NJR guarantees covering approximately $408.4 million of natural gas purchases and demand fee commitments of NJRES and NJNG not yet reflected in accounts payable on the Unaudited Condensed Consolidated Balance Sheet.
The Company enters into agreements to lease vehicles, generally over a five-year term, which qualify as operating leases. These agreements contain provisions that could require the Company to make additional cash payments at the end of the term for a portion of the residual value of the vehicles. As of June 30, 2011, the present value of the liability recognized on the Unaudited Condensed Consolidated Balance Sheets is $615,000. In the event performance under the guarantee is required, the Company's maximum future payment would be $911,000.
Page 21
New Jersey Resources Corporation
Part I
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Legal Proceedings
Manufactured Gas Plant Remediation
NJNG is responsible for the remedial cleanup of five manufactured gas plant (MGP) sites, dating back to gas operations in the late 1800s and early 1900s, which contain contaminated residues from former gas manufacturing operations. NJNG is currently involved in administrative proceedings with the New Jersey Department of Environmental Protection (NJDEP), as well as participating in various studies and investigations by outside consultants to determine the nature and extent of any such contaminated residues and to develop appropriate programs of remedial action, where warranted, under Administrative Consent Orders or Memoranda of Agreement with the NJDEP.
NJNG may, subject to BPU approval, recover its remediation expenditures, including carrying costs, over rolling seven-year periods pursuant to a RA approved by the BPU. In April 2010, the BPU approved the recovery of the remediation expenditures incurred through September 30, 2008, increasing the expected annual recovery from $17.7 million to approximately $20 million. As of June 30, 2011, $73.5 million of previously incurred remediation costs, net of recoveries from customers and insurance proceeds, are included in regulatory assets on the Unaudited Condensed Consolidated Balance Sheet.
In September 2010, NJNG updated an environmental review of the MGP sites, including a review of potential liability for investigation and remedial action. NJNG estimated at the time of the review that total future expenditures to remediate and monitor the five MGP sites for which it is responsible, including potential liabilities for Natural Resource Damages that might be brought by the NJDEP for alleged injury to groundwater or other natural resources concerning these sites, will be $201.6 million. NJNG's estimate of these liabilities is based upon known facts, existing technology and enacted laws and regulations in place when the review was completed. However, NJNG expects actual costs to differ from these estimates. Where it is probable that costs will be incurred, and the information is sufficient to establish a range of possible liability, NJNG accrues the best estimated amount in the range. If no point within the range is more likely than the other, it is NJNG's policy to accrue the lower end of the range. Accordingly, NJNG has recorded an MGP remediation liability and a corresponding regulatory asset of $201.6 million on the Unaudited Condensed Consolidated Balance Sheet, based on the best estimate. The actual costs to be incurred by NJNG are dependent upon several factors, including final determination of remedial action, changing technologies and governmental regulations, the ultimate ability of other responsible parties to pay and any insurance recoveries.
NJNG will continue to seek recovery of MGP-related costs through the RA. If any future regulatory position indicates that the recovery of such costs is not probable, the related non-recoverable costs would be charged to income in the period of such determination. However, because recovery of such costs is subject to BPU approval, there can be no assurance as to the ultimate recovery through the RA or the impact on the Company's results of operations, financial position or cash flows, which could be material.
General
The Company is party to various other claims, legal actions and complaints arising in the ordinary course of business. In the Company's opinion, the ultimate disposition of these matters will not have a material adverse effect on its financial condition, results of operations or cash flows.
14. | BUSINESS SEGMENT AND OTHER OPERATIONS DATA |
NJR organizes its businesses based on its products and services as well as regulatory environment. As a result, the Company manages the businesses through the following reportable segments and other operations: the Natural Gas Distribution segment consists of regulated energy and off-system, capacity and storage management operations; the Energy Services segment consists of unregulated wholesale energy operations; the Midstream Asset segment consists of NJR's investments in natural gas transportation and storage facilities; the Retail and Other operations consist of appliance and installation services, commercial real estate development, renewable energy and other investments and general corporate activities.
During fiscal 2010, NJR entered the solar energy markets and began planning for capital investments primarily consisting of residential and commercial rooftop and ground mount solar projects. NJR expects that both the capital expenditures and earnings contributions from these investments will be significant during fiscal 2011. In anticipation of the implementation of these planned projects, effective October 1, 2010, NJR established Clean Energy Ventures as a new reportable segment.
Page 22
New Jersey Resources Corporation
Part I
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Information related to the Company's various business segments and other operations is detailed below:
Three Months Ended | Nine Months Ended | |||||||||||
June 30, | June 30, | |||||||||||
(Thousands) | 2011 | 2010 | 2011 | 2010 | ||||||||
Operating revenues | ||||||||||||
Natural Gas Distribution | ||||||||||||
External customers | $ | 138,149 | $ | 105,130 | $ | 862,073 | $ | 794,311 | ||||
Intercompany | — | — | — | 8,047 | ||||||||
Energy Services | ||||||||||||
External customers | 498,834 | 364,776 | 1,449,252 | 1,193,912 | ||||||||
Intercompany | 1,579 | 24 | 55,010 | 13,254 | ||||||||
Clean Energy Ventures | 328 | — | 328 | — | ||||||||
Segment subtotal | 638,890 | 469,930 | 2,366,663 | 2,009,524 | ||||||||
Retail and Other | 10,951 | 10,058 | 26,903 | 19,803 | ||||||||
Eliminations | (1,672 | ) | (94 | ) | (55,258 | ) | (21,541 | ) | ||||
Total | $ | 648,169 | $ | 479,894 | $ | 2,338,308 | $ | 2,007,786 | ||||
Depreciation and amortization | ||||||||||||
Natural Gas Distribution | $ | 8,192 | $ | 7,939 | $ | 24,650 | $ | 23,321 | ||||
Energy Services | 15 | 37 | 46 | 136 | ||||||||
Midstream Assets | 1 | 1 | 4 | 4 | ||||||||
Clean Energy Ventures | 115 | — | 143 | — | ||||||||
Segment subtotal | 8,323 | 7,977 | 24,843 | 23,461 | ||||||||
Retail and Other | 191 | 159 | 602 | 475 | ||||||||
Total | $ | 8,514 | $ | 8,136 | $ | 25,445 | $ | 23,936 | ||||
Interest income (1) | ||||||||||||
Natural Gas Distribution | $ | 304 | $ | 608 | $ | 844 | $ | 1,508 | ||||
Energy Services | 1 | 7 | 9 | 11 | ||||||||
Midstream Assets | 225 | 227 | 677 | 658 | ||||||||
Segment subtotal | 530 | 842 | 1,530 | 2,177 | ||||||||
Retail and Other | 1 | (4 | ) | 2 | 3 | |||||||
Eliminations | (220 | ) | (216 | ) | (658 | ) | (642 | ) | ||||
Total | $ | 311 | $ | 622 | $ | 874 | $ | 1,538 |
(1) | Included in other income in the Unaudited Condensed Consolidated Statement of Operations. |
Page 23
New Jersey Resources Corporation
Part I
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Three Months Ended | Nine Months Ended | |||||||||||
June 30, | June 30, | |||||||||||
(Thousands) | 2011 | 2010 | 2011 | 2010 | ||||||||
Interest expense, net of capitalized interest | ||||||||||||
Natural Gas Distribution | $ | 3,630 | $ | 4,139 | $ | 11,454 | $ | 12,545 | ||||
Energy Services | 193 | 425 | 792 | 917 | ||||||||
Midstream Assets | 803 | 380 | 2,428 | 2,037 | ||||||||
Clean Energy Ventures | 14 | — | 21 | — | ||||||||
Segment subtotal | 4,640 | 4,944 | 14,695 | 15,499 | ||||||||
Retail and Other | 104 | 294 | 390 | 447 | ||||||||
Total | $ | 4,744 | $ | 5,238 | $ | 15,085 | $ | 15,946 | ||||
Income tax provision (benefit) | ||||||||||||
Natural Gas Distribution | $ | 3,283 | $ | 2,081 | $ | 44,162 | $ | 41,326 | ||||
Energy Services | 1,949 | (13,316 | ) | 8,632 | 25,506 | |||||||
Midstream Assets | 1,281 | 1,173 | 3,951 | 3,073 | ||||||||
Clean Energy Ventures | (898 | ) | — | (7,608 | ) | — | ||||||
Segment subtotal | 5,615 | (10,062 | ) | 49,137 | 69,905 | |||||||
Retail and Other | 605 | 269 | (439 | ) | (1,751 | ) | ||||||
Eliminations | (23 | ) | (762 | ) | (36 | ) | (88 | ) | ||||
Total | $ | 6,197 | $ | (10,555 | ) | $ | 48,662 | $ | 68,066 | |||
Equity in earnings of affiliates | ||||||||||||
Midstream Assets | $ | 3,891 | $ | 2,538 | $ | 11,871 | $ | 10,261 | ||||
Segment subtotal | 3,891 | 2,538 | 11,871 | 10,261 | ||||||||
Eliminations | (934 | ) | (557 | ) | (2,387 | ) | (2,376 | ) | ||||
Total | $ | 2,957 | $ | 1,981 | $ | 9,484 | $ | 7,885 | ||||
Net financial earnings (loss) | ||||||||||||
Natural Gas Distribution | $ | 5,979 | $ | 6,109 | $ | 74,375 | $ | 70,087 | ||||
Energy Services | 213 | 3,336 | 19,381 | 29,347 | ||||||||
Midstream Assets | 1,847 | 1,828 | 5,705 | 5,218 | ||||||||
Clean Energy Ventures | 259 | — | 5,484 | — | ||||||||
Segment subtotal | 8,298 | 11,273 | 104,945 | 104,652 | ||||||||
Retail and Other | 1,401 | 314 | 913 | (1,641 | ) | |||||||
Total | $ | 9,699 | $ | 11,587 | $ | 105,858 | $ | 103,011 | ||||
Capital expenditures | ||||||||||||
Natural Gas Distribution | $ | 30,783 | $ | 23,778 | $ | 77,969 | $ | 55,948 | ||||
Clean Energy Ventures | 7,040 | — | 16,977 | — | ||||||||
Segment subtotal | 37,823 | 23,778 | 94,946 | 55,948 | ||||||||
Retail and Other | 1,012 | 367 | 2,975 | 460 | ||||||||
Total | $ | 38,835 | $ | 24,145 | $ | 97,921 | $ | 56,408 | ||||
Investments in equity method investees | ||||||||||||
Midstream Assets | $ | — | $ | — | $ | — | $ | 4,300 | ||||
Total | $ | — | $ | — | $ | — | $ | 4,300 |
Page 24
New Jersey Resources Corporation
Part I
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The chief operating decision maker of the Company is the Chief Executive Officer (CEO). The CEO uses net financial earnings as a measure of profit or loss in measuring the results of the Company's segments and operations. A reconciliation of consolidated net financial earnings to consolidated net income is as follows:
Three Months Ended | Nine Months Ended | |||||||||||
June 30, | June 30, | |||||||||||
(Thousands) | 2011 | 2010 | 2011 | 2010 | ||||||||
Consolidated net financial earnings | $ | 9,699 | $ | 11,587 | $ | 105,858 | $ | 103,011 | ||||
Less: | ||||||||||||
Unrealized (gain) loss from derivative instruments and related transactions, net of taxes (1) | (2,875 | ) | 15,886 | 33,835 | 3,936 | |||||||
Effects of economic hedging related to natural gas inventory, net of taxes | (7,800 | ) | 5,878 | (36,787 | ) | (16,867 | ) | |||||
Consolidated net income (loss) | $ | 20,374 | $ | (10,177 | ) | $ | 108,810 | $ | 115,942 |
(1) | Excludes unrealized losses (gains) related to an intercompany transaction between NJNG and NJRES that have been eliminated in consolidation of $42,000 and $16,000 for the three months ended and $74,000 and $144,000 for the nine months ended June 30, 2011 and 2010, respectively. |
The Company uses derivative instruments as economic hedges of purchases and sales of physical gas inventory. For GAAP purposes, these derivatives are recorded at fair value and related changes in fair value are included in reported earnings. Revenues and cost of gas related to physical gas flow is recognized as the gas is delivered to customers. Consequently, there is a mismatch in the timing of earnings recognition between the economic hedges and physical gas flows. Timing differences occur in two ways:
• | Unrealized gains and losses on derivatives are recognized in reported earnings in periods prior to physical gas inventory flows; and |
• | Unrealized gains and losses of prior periods are reclassified as realized gains and losses when derivatives are settled in the same period as physical gas inventory movements occur. |
Net financial earnings is a measure of the earnings based on eliminating these timing differences, to effectively match the earnings effects of the economic hedges with the physical sale of gas. Consequently, to reconcile between GAAP and net financial earnings, current period unrealized gains and losses on the derivatives are excluded from net financial earnings as a reconciling item. Additionally, realized derivative gains and losses are also included in current period net income, however net financial earnings include only realized gains and losses related to natural gas sold out of inventory, effectively matching the full earnings effects of the derivatives with realized margins on physical gas flows.
The Company's assets for the various business segments and business operations are detailed below:
(Thousands) | June 30, 2011 | September 30, 2010 | ||||
Assets at end of period: | ||||||
Natural Gas Distribution | $ | 1,906,403 | $ | 1,904,545 | ||
Energy Services | 442,980 | 432,380 | ||||
Midstream Assets | 162,516 | 159,882 | ||||
Clean Energy Ventures | 17,728 | — | ||||
Segment subtotal | 2,529,627 | 2,496,807 | ||||
Retail and Other | 72,598 | 85,864 | ||||
Intercompany assets (1) | (28,269 | ) | (19,538 | ) | ||
Total | $ | 2,573,956 | $ | 2,563,133 |
(1) | Consists of transactions between subsidiaries that are eliminated and reclassified in consolidation. |
Page 25
New Jersey Resources Corporation
Part I
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
15. | RELATED PARTY TRANSACTIONS |
Periodically, NJRES may enter into park and loan agreements with Steckman Ridge, an affiliated FERC regulated natural gas storage facility. As of June 30, 2011, NJRES has entered into storage and park and loan transactions with varying terms extending through April 2012. Demand fees expensed as a component of gas purchases in the Unaudited Condensed Consolidated Statements of Operations were $354,000 and $494,000 during the three and nine months ended June 30, 2011. As of June 30, 2011, NJRES had fees payable to Steckman Ridge in the amount of $101,000.
In December 2009, NJNG and NJRES entered into an asset management agreement that began in January 2010 and ends in March 2013. Under the terms of this agreement, NJNG will release certain transportation and storage contracts to NJRES for the entire term of the agreement. NJNG also sold approximately 1 Bcf of natural gas in storage at cost to NJRES. In return, NJNG has the option to purchase index priced gas from NJRES at NJNG's city gate and other delivery locations to maintain operational reliability. In September 2010, NJNG and NJRES entered into an another asset management agreement that began in September 2010 and ends October 2014, whereby NJNG released additional transportation contracts to NJRES for the entire term of the agreement and has the option to purchase index priced gas from NJRES at NJNG's city gate.
In January 2010, NJNG entered into a ten-year agreement effective April 1, 2010 through March 31, 2020, for 3 Bcf of firm storage capacity with Steckman Ridge. Under the terms of the agreement, NJNG incurs demand fees, at market rates, of approximately $9.3 million annually. These fees are recoverable through NJNG's BGSS mechanism. Demand fees incurred during the three and nine months ended June 30, 2011, were $2.3 million and $6.9 million, respectively. As of June 30, 2011, NJNG had fees payable to Steckman Ridge in the amount of $775,000.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Management's Overview
New Jersey Resources Corporation (NJR or the Company) is an energy services holding company providing retail natural gas service in New Jersey and wholesale natural gas and related energy services to customers in states from the Gulf Coast and Mid-Continent regions to the New England region, the West Coast and Canada through two of its subsidiaries, New Jersey Natural Gas (NJNG) and NJR Energy Services (NJRES).
Comprising the Natural Gas Distribution segment, NJNG is a natural gas utility that provides regulated retail natural gas service in central and northern New Jersey and also participates in the off-system sales and capacity release markets. NJNG is regulated by the New Jersey Board of Public Utilities (BPU).
NJRES comprises the Energy Services segment. NJRES maintains and transacts around a portfolio of physical assets consisting of natural gas storage and transportation contracts. In addition, NJRES provides wholesale energy services to non-affiliated utility and energy companies.
The Midstream Asset segment includes NJR Energy Holdings Corporation (NJREH), which primarily invests in energy-related ventures through its subsidiaries, NJNR Pipeline Company (Pipeline), which holds the Company's 5.53 percent ownership interest in Iroquois Gas and Transmission System, L.P. (Iroquois) and NJR Steckman Ridge Storage Company, which holds the Company's 50 percent combined interest in Steckman Ridge GP, LLC and Steckman Ridge, LP (collectively, Steckman Ridge), a natural gas storage facility in Pennsylvania.
NJR Clean Energy Ventures (NJRCEV) was formed for the purpose of investing in clean energy projects. During fiscal 2010, NJR entered the solar energy markets and began planning for capital investments primarily consisting of residential and commercial rooftop and ground mount solar systems. NJR expects that both the capital expenditures and earnings contributions from these investments will be significant during fiscal 2011. In anticipation of the implementation of these planned projects, effective October 1, 2010, NJR established Clean Energy Ventures (CEV) as a new reportable segment.
The retail and other business operations (Retail and Other) includes: NJR Energy Corporation (NJR Energy), a company that invests in energy-related ventures, NJR Home Services (NJRHS), which provides service, sales and installation of appliances and invested in the pilot program for residential solar energy projects; NJR Plumbing Services (NJRPS), which provides plumbing repair and installation services, Commercial Realty and Resources (CR&R), which holds and develops commercial real estate; and NJR Service Corporation (NJR Service), which provides support services to the various NJR businesses.
Page 26
New Jersey Resources Corporation
Part I
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (Continued)
Assets by business segment and operations are as follows:
($ in thousands) | June 30, 2011 | September 30, 2010 | |||||||||
Assets | |||||||||||
Natural Gas Distribution | $ | 1,906,403 | 74 | % | $ | 1,904,545 | 75 | % | |||
Energy Services | 442,980 | 17 | 432,380 | 17 | |||||||
Midstream Assets | 162,516 | 6 | 159,882 | 6 | |||||||
Clean Energy Ventures | 17,728 | 1 | — | — | |||||||
Retail and Other | 72,598 | 3 | 85,864 | 3 | |||||||
Intercompany assets (1) | (28,269 | ) | (1 | ) | (19,538 | ) | (1 | ) | |||
Total | $ | 2,573,956 | 100 | % | $ | 2,563,133 | 100 | % |
(1) | Consists of transactions between subsidiaries that are eliminated and reclassified in consolidation. |
Net income (loss) by business segment and operations are as follows:
Three Months Ended | Nine Months Ended | ||||||||||||||||||||||
June 30, | June 30, | ||||||||||||||||||||||
($ in Thousands) | 2011 | 2010 | 2011 | 2010 | |||||||||||||||||||
Net Income (Loss) | |||||||||||||||||||||||
Natural Gas Distribution | $ | 5,979 | 29 | % | $ | 6,109 | (60 | )% | $ | 74,375 | 68 | % | $ | 70,087 | 60 | % | |||||||
Energy Services | 10,930 | 54 | (18,823 | ) | 185 | 22,407 | 21 | 44,262 | 38 | ||||||||||||||
Midstream Assets | 1,847 | 9 | 1,828 | (18 | ) | 5,705 | 5 | 5,218 | 5 | ||||||||||||||
Clean Ventures Energy | 259 | 1 | — | — | 5,484 | 5 | — | — | |||||||||||||||
Retail and Other | 1,401 | 7 | 725 | (7 | ) | 913 | 1 | (3,481 | ) | (3 | ) | ||||||||||||
Intercompany net income (1) | (42 | ) | — | (16 | ) | — | (74 | ) | — | (144 | ) | — | |||||||||||
Total | $ | 20,374 | 100 | % | $ | (10,177 | ) | 100 | % | $ | 108,810 | 100 | % | $ | 115,942 | 100 | % |
(1) Consists of transactions between subsidiaries that are eliminated and reclassified in consolidation.
Included in net income are unrealized gains (losses) in the Energy Services segment of $2.9 million and $(16.3) million, after taxes, for the three months ended June 30, 2011 and 2010, respectively and realized gains (losses) of $7.8 million and $(5.9) million, after taxes, for the three months ended June 30, 2011 and 2010, respectively. Also included in net income are unrealized (losses) in the Energy Services segment of $(33.8) million and $(2) million, after taxes, for the nine months ended June 30, 2011 and 2010, respectively and realized gains of $36.8 million and $16.9 million, after taxes, for the nine months ended June 30, 2011 and 2010, respectively, which are related to financial derivative instruments that have settled and are designed to economically hedge natural gas that is still in inventory.
Net income for the three and nine months ended June 30, 2010, includes unrealized gains (losses) of $411,000 and $(1.8) million, respectively, after taxes, related to a financial natural gas swap in the Retail and Other operations that was used to economically hedge a long-term gas sale contract and has since expired.
NJRES accounts for its physical commodity contracts and its financial derivative instruments used to economically hedge the forecasted purchase, sale and transportation of natural gas at fair value on the Unaudited Condensed Consolidated Balance Sheets. Changes in the fair value of these contracts are included in earnings as a component of operating revenue and gas purchases, as appropriate, in the Unaudited Condensed Consolidated Statements of Operations. All physical commodity contracts at NJNG and NJR Energy are accounted for under accrual accounting. Accordingly, gains and losses are recognized in earnings when the contract settles and the natural gas is delivered.
Unrealized gains and losses at NJRES are the result of changes in the fair value of derivative instruments. The change in fair value of these derivative instruments at NJRES over periods of time can result in substantial volatility in reported net income. When a financial instrument settles, the result is the realization of these gains or losses. NJRES utilizes certain financial instruments to economically hedge natural gas inventory placed into storage that will be sold at a later date, all of which were contemplated as part of an entire forecasted transaction. Volatility in earnings also occurs as a result of timing differences between the settlement of the financial derivative and the sale of the corresponding natural gas that was hedged with the financial instrument. When the
Page 27
New Jersey Resources Corporation
Part I
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (Continued)
financial instrument settles and the natural gas is placed in inventory, the realized gains and losses associated with the financial instrument are recognized in earnings. However, the gains and losses associated with the economically hedged natural gas are not recognized in earnings until the natural gas inventory is sold.
Management of the Company uses non-Generally Accepted Accounting Principles (GAAP) measures, noted as “net financial earnings,” when evaluating the operating results of NJRES. Net financial earnings is a measure of the earnings based on eliminating timing differences surrounding the recognition of certain gains or losses as described above, to effectively match the earnings effects of the economic hedges with the physical sale of gas and, therefore, eliminates the impact of volatility to GAAP earnings associated with the derivative instruments.
Net financial earnings by business segment and operations are as follows:
Three Months Ended | Nine Months Ended | ||||||||||||||||||||||
June 30, | June 30, | ||||||||||||||||||||||
($ in Thousands) | 2011 | 2010 | 2011 | 2010 | |||||||||||||||||||
Net Financial Earnings (Loss) | |||||||||||||||||||||||
Natural Gas Distribution | $ | 5,979 | 62 | % | $ | 6,109 | 53 | % | $ | 74,375 | 70 | % | $ | 70,087 | 68 | % | |||||||
Energy Services | 213 | 2 | 3,336 | 29 | 19,381 | 18 | 29,347 | 29 | |||||||||||||||
Midstream Assets | 1,847 | 19 | 1,828 | 16 | 5,705 | 6 | 5,218 | 5 | |||||||||||||||
Clean Energy Ventures | 259 | 3 | — | — | 5,484 | 5 | — | — | |||||||||||||||
Retail and Other | 1,401 | 14 | 314 | 2 | 913 | 1 | (1,641 | ) | (2 | ) | |||||||||||||
Total | $ | 9,699 | 100 | % | $ | 11,587 | 100 | % | $ | 105,858 | 100 | % | $ | 103,011 | 100 | % |
Natural Gas Distribution Segment
Our distribution segment has approximately 495,300 residential and commercial customers in its service territory. The business is subject to various risks, such as those associated with adverse economic conditions, which can negatively impact customer growth, operating and financing costs, fluctuations in commodity prices, which can impact customer usage, customer conservation efforts, certain regulatory actions, and environmental remediation. It is often difficult to predict the impact of trends associated with these risks. NJNG employs certain strategies to manage the challenges it faces, including pursuing customer conversions from other fuel sources and monitoring new construction markets through contact with developers, utilizing incentive programs through BPU-approved mechanisms to reduce gas costs, pursuing rate and other regulatory strategies designed to stabilize and decouple margin, and working actively with consultants and the New Jersey Department of Environmental Protection to manage expectations related to its obligations associated with NJNG's manufactured gas plant (MGP) sites.
NJNG's operations are managed with the goal of providing safe and reliable service, growing profitably and promoting clean energy programs through several key initiatives including:
• | Earning a reasonable rate of return on the investments in its natural gas distribution system, as well as recovery of all prudently incurred costs in order to provide safe and reliable service throughout NJNG's territory; |
• | Working with the BPU and the New Jersey Division of Rate Counsel (Rate Counsel), on the continuation of the Conservation Incentive Program (CIP). The CIP allows NJNG to promote conservation programs to its customers while maintaining protection of its utility gross margin, which is a non-GAAP financial measure, against potential losses associated with reduced customer usage. CIP usage differences are calculated annually and are recovered one year following the end of the CIP usage year. See the Results of Operations section of Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations for a definition and further discussion of utility gross margin; |
• | Managing its new customer growth rate, which is expected to be approximately 1.3 percent annually over the next two years; |
• | Generating earnings from various BPU-authorized gross margin-sharing incentive programs; |
• | Maintaining the integrity of its infrastructure, while working with the BPU to accelerate certain infrastructure projects in an effort to stimulate the local and state economies; |
Page 28
New Jersey Resources Corporation
Part I
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (Continued)
• | Coordinating with the BPU on clean energy goals; and |
• | Managing the volatility of wholesale natural gas prices through a hedging program designed to keep customers' Basic Gas Supply Service (BGSS) rates as stable as possible. |
Conservation Incentive Program
The CIP allows NJNG to recover utility gross margin variations related to both weather and customer usage subject to certain conditions. An annual review of the CIP must be filed in June, coincident with NJNG's annual BGSS filing. NJNG's filing in June 2010, included recovery of $12.1 million annually, an increase of $5.2 million, for accrued and estimated CIP amounts through September 30, 2010. This increase was approved by the BPU to be effective October 1, 2010. On June 1, 2011, NJNG filed for a change in the CIP rates, effective October 1, 2011. The proposed rates result in an increase to all classes except residential heat, which represents a decrease. See Note 3. Regulation and the Results of Operations section of Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations for more information on the impact to utility gross margin.
As of June 30, 2011, NJNG has $9.9 million related to CIP accrued to be recovered in regulatory assets in the Unaudited Condensed Consolidated Balance Sheets.
Customer growth
In conducting NJNG's business, management focuses on factors it believes may have significant influence on its future financial results. NJNG's policy is to work with all stakeholders, including customers, regulators and policymakers, to achieve favorable results. These factors include the rate of NJNG's customer growth in its service territory, which can be influenced by political and regulatory policies, the delivered cost of natural gas compared with competing fuels, interest rates and general economic conditions.
NJNG added 6,189 new customers during fiscal 2010 or an increase of 1.3 percent, which will contribute an additional $3.3 million in utility gross margin. During the nine months ended June 30, 2011, NJNG has added 4,610 new customers, or an increase of 0.9 percent respectively, which is expected to contribute annual utility gross margin of approximately $2.4 million. NJNG currently expects to add, in total, approximately 12,000 to 14,000 new customers in fiscal 2011 and 2012, and expects this growth rate to increase utility gross margin under NJNG's base rates by approximately $3.4 million annually, as calculated under NJNG's CIP tariff.
Commodity prices
Our natural gas distribution segment is affected by the price of natural gas, which can have a significant impact on our cash flows, short-term financing costs, gas costs recovered from customers, NJNG's ability to collect accounts receivable, which impacts our bad debt expense, and our ability to maintain a competitive advantage over other fuel sources. Natural gas commodity prices may experience high volatility as indicated by New York Mercantile Exchange (NYMEX) settlement prices, which ranged from $3.29 per MMBtu to $4.38 per MMBtu and from $3.73 per MMBtu to $5.81 per MMBtu during the nine months ended June 30, 2011 and 2010, respectively. As of June 30, 2011, forward natural gas prices for the next twelve months on the NYMEX, which serve as a market indicator, averaged $4.65 per MMBtu, 14.2 percent higher than the average settlement price of $4.07 per MMBtu during the nine months ended June 30, 2011.
In order to provide price stability to its natural gas supply portfolio, NJNG employs a hedging strategy with the goal of having at least 75 percent of the Company's projected winter gas purchase volumes hedged by the beginning of the winter heating season and at least 25 percent of the gas purchase requirements for the following April through March period. This is accomplished with financial derivatives, including those that are used in the incentive programs described below.
NJNG's cost of gas is passed through to our customers, without markup, by applying NJNG's authorized BGSS tariff rate to actual therms delivered. There is no utility gross margin associated with BGSS costs, therefore, changes in such costs do not impact NJNG's earnings. NJNG's cost of gas includes the purchased cost of the natural gas, fees paid to pipelines and storage facilities, adjustments as a result of incentive programs, and hedging transactions. NJNG monitors its actual gas costs in comparison to its tariff rates in order to manage its cash flows associated with its allowed recovery of gas costs, which is facilitated through BPU-approved deferred accounting and the BGSS pricing mechanism. Accordingly, NJNG occasionally adjusts its periodic BGSS
Page 29
New Jersey Resources Corporation
Part I
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (Continued)
rates for its residential and small commercial customers to reflect changes in the cost of natural gas and can extend credits or refunds to its customers when the commodity cost is trending lower than the current BGSS rate. BGSS rates for its large commercial customers are changed monthly based on NYMEX prices.
During the nine months ended June 30, 2010, NJNG issued refunds and bill credits of $110.4 million to customers and implemented BGSS rate reductions as a result of the continuing decline in commodity prices. Commodity prices have since stabilized in comparison to NJNG's tariff rate. NJNG manages these prices from time to time with slight rate adjustments. The BPU approved a 3.5 percent BGSS price decrease for the average residential heat customer, effective September 16, 2010. There have been no refunds or rate adjustments during the nine months ended June 30, 2011. On June 1, 2011, NJNG filed for a 9.1 percent BGSS price decrease for the average residential heat customer as a result of lower natural gas prices and natural gas purchasing strategies, which would go into effect October 1, 2011, upon approval. A more detailed discussion of the impacts of the price of natural gas to operating revenues, gas purchases and cash flows can be found in the Results of Operations and Cash Flow sections of Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
Incentive programs
NJNG is eligible to receive financial incentives for reducing BGSS costs through a series of utility gross margin-sharing programs that include off-system sales, capacity release, storage incentive and financial risk management (FRM) programs. The current programs expire on October 31, 2011, unless an extension is approved by the BPU, and success of the programs is subject to market conditions. On April 1, 2011, NJNG filed a petition with the BPU for approval of a five-year extension of the Company's BGSS incentive programs through October 31, 2016. NJNG also requested approval of a provision designed to permit the Company to propose modifications to the margin sharing programs, including new incentives, should performance of the incentives or market conditions warrant re-evaluation of the existing structure. On July 25, 2011, NJNG, the BPU and Rate Counsel executed a Stipulation to extend NJNG's margin-sharing incentive programs for four years through October 31, 2015, under the same terms of its previous agreement with respect to margin-sharing percentages. This agreement also permits NJNG to annually propose a process to evaluate and discuss alternative incentive programs, should performance of the existing incentives or market conditions warrant re-evaluation. BPU approval is expected before the beginning of fiscal 2012.
Utility gross margin from incentive programs during the three months ended June 30, 2011 and 2010 was $1.5 million and $2 million, respectively and was $7.7 million and $7.4 million during the nine months ended June 30, 2011 and 2010, respectively. A more detailed discussion of the impacts to margin can be found in the Results of Operations section of Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
Environmental remediation
As a regulated company, NJNG is required to recognize the impact of regulatory decisions on its financial statements. As a result, significant costs are deferred and treated as regulatory assets, pending BPU decisions regarding their ultimate recovery from customers. The most significant costs incurred that are subject to this accounting treatment include MGP remediation costs and wholesale natural gas costs (recovered through BGSS). Actual remediation costs may vary from management's estimates due to the developing nature of remediation requirements, regulatory decisions by the New Jersey Department of Environmental Protection (NJDEP) and related litigation. NJNG reviews these costs annually, at the end of each fiscal year, and adjusts its liability and corresponding regulatory asset as necessary to reflect its expected obligation.
NJNG has recognized a regulatory asset and an obligation of $201.6 million as of June 30, 2011, an increase of $54.9 million, or 37.4 percent over the prior year. The increase during fiscal 2011 was due primarily to the annual reassessment of the MGP remediation and related costs, which caused an increase in four out of the five sites as well as a change to using the best estimate within a range of potential liability amounts. Prior to the change, NJNG used the minimum cost estimate within the range since the most likely outcome was not available.
NJNG is currently authorized to recover remediation costs of approximately $20 million annually. If there are changes in the regulatory position on the recovery of these costs as determined by the BPU, such costs would be charged to income in the period of such determination.
Page 30
New Jersey Resources Corporation
Part I
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (Continued)
Infrastructure projects
NJNG has significant annual capital expenditures associated with the management of its natural gas distribution and transmission system and its associated pipeline integrity.
During fiscal 2009, NJNG implemented its Accelerated Infrastructure Program (AIP), as approved by the BPU, to enhance the reliability of its gas distribution system and to support economic development and job growth in New Jersey, commencing construction on fourteen infrastructure projects (AIP I) at an approved cost of $70.8 million. NJNG defers the costs associated with the AIP projects, including NJNG's weighted cost of capital, and upon regulatory approval recovers this investment through its base rates. In September 2010, the BPU provisionally approved an annual recovery through base rates of $4.2 million related to AIP I, including an overall weighted average cost of capital of 7.76 percent.
On October 20, 2010, NJNG filed a petition with the BPU for approval of an extension to NJNG's Accelerated Energy Infrastructure Program (AIP II) for capital investments to be made through August 31, 2012, in the amount of $52.2 million. On January 24, 2011, NJNG amended the amount of this petition to $60.2 million for capital investments to be made through October 31, 2012 . NJNG requested approval from the BPU for the recovery of expenditures through base rates, which would include the Company's overall weighted cost of capital of 7.76 percent authorized in its last base rate case. On March 30, 2011, the BPU approved the amended AIP II filing. NJNG will submit filings requesting recovery of AIP II investment costs through base rates, which will include an overall weighted average cost of capital of 7.12 percent that includes a 10.3 percent return on equity.
On June 1, 2011, NJNG filed for AIP base rate cost recovery, which represents an increase of $4.7 million to $8.9 million annually, related to AIP I and AIP II infrastructure investments installed in NJNG's distribution and transmission systems, requesting rate changes to be effective on October 1, 2011. An additional filing will be submitted in October 2012, requesting rate changes to be effective in January 1, 2013.
NJNG has committed capital expenditures for fiscal 2011 of $108.2 million, of which $26 million is related to AIP I and $11 million related to AIP II.
Energy efficiency
NJNG has implemented economic stimulus programs in order to promote energy efficiency (EE) and conservation while stimulating the state's economy. In July 2009, the BPU approved expenditures of up to approximately $21.1 million to support three EE Programs. As a result, NJNG has a recovery mechanism in place and defers the costs associated with the EE projects, including NJNG's overall weighted average cost of capital. As of June 30, 2011, NJNG has spent a total of $20.1 million related to these programs.
In March 2010, NJNG filed for approval of its Regional Greenhouse Gas Initiative (RGGI) Program with the BPU and requested recovery of expenditures related to a series of energy-efficiency and solar energy programs for eligible residential and commercial customers through which enhanced rebates and incentives are provided. In September 2010, NJNG received approval of its RGGI programs from the BPU, allowing NJNG to offer certain residential and commercial energy-efficiency programs, through which enhanced rebates and incentives are provided. The program, which became effective on January 1, 2011, will run for an initial period of twelve months. NJNG will recover these energy-efficiency investments of up to $9.6 million over a four or five-year period, depending on the commencement date of the specific initiative. The recovery period for costs associated with other approved components of the RGGI program varies and can be up to ten years. The approved program costs will be subject to deferred accounting and recovery of energy-efficient investments will include NJNG's weighted average cost of capital. As of June 30, 2011, NJNG has spent a total of $5.4 million related to this program. On January 7, 2011, NJNG notified the BPU that the solar incentive programs initially included in the March 2010 filing and subsequently reserved for future discussions were withdrawn.
On June 1, 2011, NJNG filed its annual EE Program filing with the BPU. On July 15, 2011, the annual filing was amended to request that the current rate remain the same. Also on July 15, 2011, NJNG filed a separate petition to extend its current EE Programs through December 31, 2012.
Page 31
New Jersey Resources Corporation
Part I
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (Continued)
Other
Due to the capital-intensive nature of NJNG's operations and the seasonal nature of its working capital requirements, significant changes in interest rates can also impact NJNG's results. A more detailed discussion can be found in the Liquidity and Capital Resources and Cash Flow sections of Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
Energy Services Segment
NJRES provides unregulated wholesale energy services and engages in the business of optimizing natural gas storage and transportation assets. The rights to these assets are contractually acquired in anticipation of delivering natural gas or performing asset management activities for customers or in conjunction with identifying arbitrage opportunities that exist in the marketplace. These arbitrage opportunities occur as a result of price differences between market locations and/or time horizons. These activities are conducted in the areas in which we have expertise and include states from the Gulf Coast and Mid-continent regions to the Appalachian and Northeast regions, the West Coast and Canada. NJRES' optimization activities are impacted by changes in pricing between geographic locations and/or time periods. Margins are affected by volatility in natural gas markets and as a result NJRES' financial performance can significantly differ during periods of low or high volatility.
More specifically, NJRES activities consist of the following elements, which provide for growth, while focusing on maintaining a low-risk operating and counterparty credit profile:
• | Identifying and benefiting from variations in pricing of natural gas transportation and storage assets due to location or timing differences of natural gas prices to generate gross margin; |
• | Providing natural gas portfolio management services to nonaffiliated utilities, natural gas producers and electric generation facilities; |
• | Leveraging transactions for the delivery of natural gas to customers by aggregating the natural gas commodity costs and transportation costs in order to minimize the total cost required to provide and deliver natural gas to NJRES' customers by identifying the lowest cost alternative with the natural gas supply, transportation availability and markets to which NJRES is able to access through its business footprint and contractual asset portfolio; and |
• | Managing economic hedging programs that are designed to mitigate adverse market price fluctuations in natural gas transportation and storage commitments. |
NJRES focuses on creating value from natural gas assets, which are typically amassed through contractual rights to natural gas transportation and storage capacity. NJRES has developed a portfolio of natural gas storage and transportation capacity in states in the Northeast, Gulf Coast, Mid-continent, Appalachian, and West Coast regions of the United States and Canada. These assets become more valuable when prices change between these areas and across time periods. On a forward basis, NJRES may lock in these price differentials through the use of financial instruments. In addition, NJRES seeks to optimize these assets on a daily basis as market conditions change by evaluating all the natural gas supplies and transportation to which it has access. When market conditions allow, this enables NJRES to capture geographic pricing differences across these various regions as delivered natural gas prices change. NJRES focuses on earning a margin on a single original transaction and then utilizing that transaction, and the changes in prices across the regions or across time periods, as the basis to further improve the initial result. This strategy is in large part dependent on volatility in natural gas markets, and in a period of economic downturn and resulting lower industrial gas consumption is more challenging to execute.
NJRES transacts with a variety of counterparties including local distribution companies, industrial companies, electric generators, retail aggregators, natural gas producers and other wholesale marketing companies. The physical sales commitments to these counterparties allows NJRES to leverage its transportation and storage capacity. These physical sale commitments are managed in an aggregate fashion, and as a result, gives NJRES the ability to extract more value from its portfolio of natural gas storage and pipeline transportation capacity. NJRES' portfolio management customers include nonaffiliated utilities and electric generation plants. Services provided by NJRES include optimization of underutilized natural gas assets and basic gas supply functions.
During fiscal 2010 there was significant expansion of natural gas resources in the Northeast region as a result of drilling along the Marcellus Shale, which caused a general decrease in volatility in natural gas pricing in the Northeast. This has generally reduced the value of transportation and storage capacity in the northeast, a core market for NJRES. This downturn in volatility
Page 32
New Jersey Resources Corporation
Part I
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (Continued)
and capacity values could have a lasting effect on the earnings of NJRES. However, NJRES believes there is an opportunity to provide asset management services to exploration and production companies working on the development of these natural gas resources.
In conducting its business, NJRES mitigates risk by following formal risk management guidelines, including transaction limits, approval processes, segregation of duties, and formal contract and credit review and approval procedures. NJRES continuously monitors and seeks to reduce the risk associated with its credit exposures with its various counterparties. The Risk Management Committee (RMC) of NJR oversees compliance with these established guidelines.
Midstream Assets Segment
NJR's subsidiary, NJR Energy Holdings Corporation, invests in natural gas “midstream” assets, such as natural gas transportation and storage facilities. NJR believes that acquiring, owning and developing these midstream assets, which operate under a tariff structure that has either regulated or market-based rates, can provide a growth opportunity for the Company. To that end, NJR has ownership interests in Iroquois, a natural gas pipeline operating with regulated rates and Steckman Ridge, a storage facility that operates under market-based rates, and is pursuing other potential opportunities that meet its investment and development criteria.
As of June 30, 2011, NJR's investments in Steckman Ridge and Iroquois, including capitalized costs and equity in earnings, and net of cash distributions received, were $136 million and $25.7 million, respectively. NJR could have an additional funding obligation of up to $5.7 million related to Steckman Ridge, should there be additional construction on the storage facility to improve performance.
Clean Energy Ventures Segment
NJRCEV actively pursues opportunities in the solar renewable energy markets and has entered into various agreements to install solar equipment involving both residential and commercial projects. The investments are expected to qualify for a 30 percent federal investment tax credit (ITC) and once the projects commence operations, for each Megawatt hour (Mwh) of electricity produced, a Solar Renewable Energy Certificate (SREC) will be created. NJRCEV currently estimates capital expenditures of between $70 and $80 million in fiscal 2011. These investments are subject to a variety of factors, including logistics associated with the start-up of commercial solar projects, such as timing of construction schedules, the permitting and regulatory process, and any delays related to electric grid interconnection, which may affect our ability to commence operations at these projects on a timely basis or, at all. As a result, if these projects are not placed in service prior to September 30, 2011, a failure to qualify for ITCs and SRECs could have a significant adverse impact on earnings. In addition, since the primary contributors toward the value of qualifying renewable energy projects are the ITC and SRECs, changes in the federal statutes related to the ITC or in the markets surrounding SRECs, which can be traded or sold to load serving entities that need to comply with state renewable energy standards, could also have a significant impact on earnings.
Retail and Other Operations
The financial results of Retail and Other have consisted primarily of the operating results of NJRHS, CR&R, and NJR Energy. NJRHS provides service, sales and installation of appliances to approximately 135,900 customers and has been focused on growing its installation business and expanding its service contract customer base. In addition, NJRHS has investments in residential solar energy projects. CR&R seeks additional opportunities to enhance the value of its undeveloped land and investments. NJR Energy invests in other energy-related ventures through its operating subsidiaries. Retail and Other operations also include organizational expenses incurred at NJR.
Critical Accounting Policies
A summary of NJR's critical accounting policies is included in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations of its Annual Report on Form 10-K for the period ended September 30, 2010. NJR's critical accounting policies have not changed from those reported in the 2010 Annual Report on Form 10-K.
Recently Issued Accounting Standards
Refer to Note 2. Summary of Significant Accounting Policies for discussion of recently issued accounting standards.
Page 33
New Jersey Resources Corporation
Part I
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (Continued)
Results of Operations
Consolidated
Net income increased $30.6 million during the three months ended June 30, 2011 to $20.4 million, compared with a net loss of $(10.2) million during the three months ended June 30, 2010. Earnings for the three months ended June 30, 2011, were $0.49 per basic share and and $0.49 per diluted share, compared with losses of $(0.25) per basic share and $(0.25) per diluted share for the three months ended June 30, 2010. Changes in net income were primarily driven by unrealized as well as certain realized gains associated with natural gas in inventory of $2.9 million and $7.8 million, respectively, after taxes, for the three months ended June 30, 2011, which were due primarily to the change in the fair market value of financial derivative instruments as a result of market conditions, compared with unrealized and realized (losses) of $(15.9) million and $(5.9) million, respectively, after taxes, for the three months ended June 30, 2010.
Net income decreased $7.1 million during the nine months ended June 30, 2011 to $108.8 million, compared with $115.9 million during the nine months ended June 30, 2010. Earnings for the nine months ended June 30, 2011, were $2.63 per basic share and and $2.62 per diluted share, compared with earnings of $2.80 per basic share and $2.78 per diluted share for the nine months ended June 30, 2010. Changes in net income were primarily driven by unrealized (losses) of $(33.8) million and $(3.9) million, after taxes, for the nine months ended June 30, 2011 and 2010, respectively, which is offset by certain realized gains associated with natural gas in inventory of $36.8 million and $16.9 million, after taxes, for the nine months ended June 30, 2011 and 2010, respectively, as previously discussed. Also offsetting the decrease was improved earnings in Retail and Other operations and Natural Gas Distribution segment.
The Company's operating revenues and gas purchases are as follows:
Three Months Ended | Nine Months Ended | ||||||||||||||||
June 30, | June 30, | ||||||||||||||||
($ in Thousands) | 2011 | 2010 | % change | 2011 | 2010 | % change | |||||||||||
Operating revenues (1) | $ | 648,169 | $ | 479,894 | 35.1 | % | $ | 2,338,308 | $ | 2,007,786 | 16.5 | % | |||||
Gas purchases (1) | $ | 557,120 | $ | 440,791 | 26.4 | % | $ | 1,930,435 | $ | 1,593,561 | 21.1 | % |
(1) | Amounts include intercompany eliminating entries in Operating revenues of $1.7 million and $94,000 and in Gas purchases of $2.7 million and $774,000 for the three months ended June 30, 2011, and 2010, respectively and $55.3 million and in Operating revenues of $21.5 million and in Gas purchases of $57.9 million and $24.1 million for the nine months ended June 30, 2011, and 2010, respectively. |
Operating revenues and gas purchases increased $168.3 million and $116.3 million, respectively, during the three months ended June 30, 2011, compared with the three months ended June 30, 2010, due primarily to:
• | an increase in operating revenues of $135.6 million and gas purchases of $89.9 million at NJRES stemming from higher average sales and gas purchase volumes coupled with higher average prices, which correlate to the higher price levels on the NYMEX. In addition, increases in both operating revenue and gas purchases include unrealized and realized gains during fiscal 2011, compared with unrealized and realized losses during fiscal 2010; |
• | an increase in operating revenues of $33 million and gas purchases of $28.4 million at NJNG due primarily to bill credits and refunds during fiscal 2010, that did not recur during fiscal 2011, partially offset by a decrease in off-system sales; and |
• | an increase in operating revenues of $893,000 at Retail and Other due primarily to increased installations and service contract revenue at NJRHS, in addition to unrealized (losses) associated with financial derivatives at NJR Energy during fiscal 2010 that did not recur in fiscal 2011. |
Operating revenues and gas purchases increased $330.5 million and $336.9 million, respectively, during the nine months ended June 30, 2011, compared with the nine months ended June 30, 2010, due primarily to:
• | an increase in operating revenues of $297.1 million and gas purchases of $335.8 million at NJRES stemming from higher average sales and gas purchase volumes, partially offset by lower average prices, which correlate to the lower price levels on the NYMEX. In addition, both operating revenue and gas purchases include higher realized gains during fiscal 2011, compared with fiscal 2010, partially offset by higher unrealized losses during fiscal 2011, compared with fiscal 2010; |
Page 34
New Jersey Resources Corporation
Part I
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (Continued)
• | an increase in operating revenues and gas purchases of $59.7 million and $34.9 million, respectively, at NJNG primarily as a result of additional bill credits and refunds during fiscal 2010, that did not recur during fiscal 2011, along with an increase in firm sales due to higher therm usage due primarily to weather being 7.5 percent colder than the prior year, partially offset by a decrease in off-system sales; and |
• | an increase in operating revenues of $7.1 million at Retail and Other due primarily to increased installations and service contract revenue at NJRHS, in addition to unrealized losses associated with financial derivatives at NJR Energy during fiscal 2010 that did not recur in fiscal 2011. |
Natural Gas Distribution Segment
NJNG is a local natural gas distribution company that provides regulated retail energy services to approximately 495,300 residential and commercial customers in central and northern New Jersey and participates in the off-system sales and capacity release markets.
NJNG's business is seasonal by nature, as weather conditions directly influence the volume of natural gas delivered. Specifically, customer demand substantially increases during the winter months when natural gas is used for heating purposes. As a result, NJNG receives most of its gas distribution revenues during the first and second fiscal quarters and is subject to variations in earnings and working capital during the year.
The Electric Discount and Energy Competition Act (EDECA) provides the framework for New Jersey's retail energy markets, which are open to competition from other electric and natural gas suppliers. Currently, NJNG's residential and commercial markets are open to competition, and its rates are segregated between BGSS (natural gas commodity) and delivery (i.e., transportation) components. NJNG earns no utility gross margin on the commodity portion of its natural gas sales. NJNG earns utility gross margin through the delivery of natural gas to its customers and, therefore, is not negatively affected by customers who use its transportation service and purchase natural gas from another supplier. Under an existing order from the BPU, BGSS can be provided by suppliers other than the state's natural gas utilities, however, all customers who purchase natural gas from another supplier continue to use NJNG for transportation service.
Operating Results
NJNG's financial results are as follows:
Three Months Ended | Nine Months Ended | |||||||||||
June 30, | June 30, | |||||||||||
(Thousands) | 2011 | 2010 | 2011 | 2010 | ||||||||
Utility Gross Margin | ||||||||||||
Operating revenues | $ | 138,149 | $ | 105,130 | $ | 862,073 | $ | 802,358 | ||||
Less: | ||||||||||||
Gas purchases | 76,772 | 48,401 | 527,371 | 492,489 | ||||||||
Energy and other taxes | 7,826 | 4,738 | 53,604 | 43,955 | ||||||||
Regulatory rider expense | 6,518 | 6,183 | 47,520 | 41,103 | ||||||||
Total Utility Gross Margin | 47,033 | 45,808 | 233,578 | 224,811 | ||||||||
Operation and maintenance expense | 26,129 | 25,856 | 78,072 | 77,551 | ||||||||
Depreciation and amortization | 8,192 | 7,939 | 24,650 | 23,321 | ||||||||
Other taxes not reflected in utility gross margin | 913 | 899 | 3,056 | 3,141 | ||||||||
Operating income | 11,799 | 11,114 | 127,800 | 120,798 | ||||||||
Other income | 1,093 | 1,215 | 2,191 | 3,160 | ||||||||
Interest expense, net of capitalized interest | 3,630 | 4,139 | 11,454 | 12,545 | ||||||||
Income tax provision | 3,283 | 2,081 | 44,162 | 41,326 | ||||||||
Net income | $ | 5,979 | $ | 6,109 | $ | 74,375 | $ | 70,087 |
Page 35
New Jersey Resources Corporation
Part I
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (Continued)
Utility Gross Margin
NJNG's utility gross margin is a non-GAAP financial measure defined as natural gas revenues less natural gas purchases, sales tax, a Transitional Energy Facilities Assessment (TEFA) and regulatory rider expenses, and may not be comparable to the definition of gross margin used by others in the natural gas distribution business and other industries.
Management believes that utility gross margin provides a more meaningful basis than revenue for evaluating utility operations since natural gas costs, sales tax, TEFA and regulatory rider expenses are included in operating revenue and passed through to customers and, therefore, have no effect on utility gross margin.
Natural gas costs are charged to operating expenses on the basis of therm sales at the prices in NJNG's BGSS tariff approved by the BPU. The BGSS tariff rate includes projected natural gas costs, which include fees paid to pipelines and storage facilities, and the impact of hedging activities and incentive programs. Any underrecoveries or overrecoveries from the projected amounts are deferred and reflected in the BGSS tariff rate in subsequent years.
TEFA, which is included in energy and other taxes in the Unaudited Condensed Consolidated Statements of Operations, is calculated on a per-therm basis and excludes sales to cogeneration facilities, other utilities and off-system sales. TEFA represents a regulatory allowed assessment imposed on all energy providers in the state of New Jersey, as TEFA has replaced the previously used utility gross receipts and franchise tax formula. TEFA will be phased out over a three-year period commencing January 1, 2012.
Regulatory rider expenses consist of recovery of state-mandated programs, the remediation adjustment (RA) and energy efficiency costs. These expenses are offset by corresponding revenues and are calculated on a per-therm basis.
NJNG's operating revenues and gas purchases increased $33 million, or 31.4 percent, and $28.4 million, or 58.6 percent, respectively, during the three months ended June 30, 2011, compared with the three months ended June 30, 2010, as a result of:
• | an increase in operating revenues and gas purchases in the amount of $37.7 million and $35.2 million, respectively, related to a combination of BGSS bill credits and refunds, inclusive of sales tax credits in the amount of $2.5 million during the three months ended June 30, 2010, that did not recur during the three months ended June 30, 2011; |
• | an increase in operating revenues related to firm sales in the amount of $3.4 million as a result of higher therm usage due primarily to weather being 15.1 percent colder than the prior year, partially offset by a decrease in operating revenue of $1.9 million, as a result of lower accruals relating to the CIP; |
• | an increase in operating revenues and gas purchases related to firm sales in the amount of $2.5 million and $2.4 million, respectively, as a result of an increase in the average periodic BGSS rate per therm of approximately 46.2 percent for residential, 56.6 percent for small commercial customers and 8.2 percent for large commercial customers, an increase in operating revenue of $800,000 due primarily to the increase in base rates related to AIP I, effective October 1, 2010 and an increase of $100,000 related primarily to an increase in rider rates; partially offset by |
• | a decrease of $9.9 million in both operating revenues and gas purchases related to off-system sales, due primarily to a reduction of 26 percent in volumes of natural gas sold as a result of an increase in the utilization of NJNG's transport capacity for capacity release volumes, coupled with a 1.5 percent decrease in price. |
NJNG's operating revenues and gas purchases increased by $59.7 million, or 7.4 percent, and by $34.9 million, or 7.1 percent, respectively, during the nine months ended June 30, 2011, compared with the nine months ended June 30, 2010, as a result of:
• | an increase in operating revenues and gas purchases in the amount of $110.4 million and $103.2 million, respectively, due to a combination of refunds and bill credits, inclusive of sales tax refunds of $7.2 million, during the nine months ended June 30, 2010, that did not recur during the nine months ended June 30, 2011; |
• | an increase in operating revenues and gas purchases related to firm sales in the amount of $26.7 million and $10.3 million, respectively, as a result of higher therm usage due primarily to weather being 7.5 percent colder than the prior year, partially offset by a decrease in operating revenue of $7.7 million, as a result of lower CIP accruals; partially offset by |
Page 36
New Jersey Resources Corporation
Part I
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (Continued)
• | a decrease of $64.2 million in both operating revenues and gas purchases related to off-system sales, due primarily to a reduction of 19.5 percent in volumes as discussed above coupled with a 5.9 percent decrease in price; and |
• | a decrease in operating revenues and gas purchases related to firm sales in the amount of $15.7 million and $14.6 million, respectively, as a result of a decrease in the average periodic BGSS rate per therm of approximately 7.5 percent for large commercial customers, partially offset by an increase in operating revenue of $4.6 million due primarily to the increase in base rates related to AIP I and an increase of $3.6 million related primarily to an increase in rider rates. |
Sales tax and TEFA, which are presented as both components of operating revenues and operating expenses in the Unaudited Condensed Consolidated Statements of Operations, totaled $7.8 million and $4.7 million during the three months ended June 30, 2011 and 2010, respectively. For the nine months ended June 30, 2011 and 2010, sales tax and TEFA totaled $53.6 million and $44 million, respectively. The increase for both periods was due primarily to an increase in operating revenue from firm sales of $45.9 million and $138.8 million for the three and nine months ended June 30, 2011, respectively.
Regulatory rider expenses are calculated on a per-therm basis and totaled $6.5 million and $6.2 million during the three months ended June 30, 2011 and 2010, respectively and totaled $47.5 million and $41.1 million during the nine months ended June 30, 2011 and 2010, respectively. During the nine months ended June 30, 2011, the increase in expense, which is offset by a corresponding increase in operating revenue, is due primarily to a 7.4 percent increase in rates and a 7.6 percent increase in usage compared with the nine months ended June 30, 2010.
NJNG's utility gross margin is comprised of the following components:
• | Utility firm gross margin, which is derived from residential and commercial customers who receive natural gas service from NJNG through either sales or transportation tariffs; |
• | Incentive programs, where gross margins generated or savings achieved from BPU-approved Off-system Sales, Capacity Release, Financial Risk Management or Storage Incentive programs (defined below in Incentive Programs) are shared between customers and NJNG; and |
•Utility gross margin from interruptible customers who have the ability to switch to alternative fuels.
The following table summarizes Utility Gross Margin and Throughput in billion cubic feet (Bcf) of natural gas by type:
Three Months Ended | Nine Months Ended | |||||||||||||||||||||
June 30, | June 30, | |||||||||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||||||||
($ in thousands) | Margin | Bcf | Margin | Bcf | Margin | Bcf | Margin | Bcf | ||||||||||||||
Utility Gross Margin/Throughput | ||||||||||||||||||||||
Residential | $ | 28,725 | 5.0 | $ | 28,556 | 4.6 | $ | 152,282 | 39.6 | $ | 150,384 | 37.5 | ||||||||||
Commercial, Industrial and other | 8,568 | 1.0 | 8,530 | 0.9 | 38,461 | 7.7 | 38,202 | 7.6 | ||||||||||||||
Firm Transportation | 8,103 | 1.7 | 6,613 | 1.3 | 34,869 | 11.0 | 28,573 | 9.0 | ||||||||||||||
Total Utility Firm Gross Margin/Throughput | 45,396 | 7.7 | 43,699 | 6.8 | 225,612 | 58.3 | 217,159 | 54.1 | ||||||||||||||
Incentive programs | 1,524 | 23.5 | 2,006 | 16.1 | 7,679 | 79.2 | 7,387 | 60.2 | ||||||||||||||
Interruptible | 113 | 2.2 | 103 | 2.0 | 287 | 4.8 | 265 | 3.8 | ||||||||||||||
Total Utility Gross Margin/Throughput | $ | 47,033 | 33.4 | $ | 45,808 | 24.9 | $ | 233,578 | 142.3 | $ | 224,811 | 118.1 |
Utility Firm Gross Margin
Utility firm gross margin is earned from residential and commercial customers who receive natural gas service from NJNG through either sales tariffs, which include a commodity and delivery component, or transportation tariffs, which include a delivery component only.
Page 37
New Jersey Resources Corporation
Part I
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (Continued)
Utility firm gross margin from residential service sales increased $169,000 and $1.9 million to $28.7 million and $152.3 million, respectively, during the three and nine months ended June 30, 2011, due primarily to an increase in base rates related to the AIP I during the three and nine months ended June 30, 2011, partially offset by a decrease in residential customers that transferred into the transportation service. Utility firm gross margin from commercial and industrial service sales remained relatively flat for the three and nine months ended June 30, 2011, compared with the three and nine months ended June 30, 2010.
Utility firm gross margin from transportation service increased $1.5 million to $8.1 million for the three months ended June 30, 2011, from $6.6 million for the three months ended June 30, 2010, and increased $6.3 million to $34.9 million for the nine months ended June 30, 2011, from $28.6 million for the nine months ended June 30, 2010. The improvement in margins during both periods in fiscal 2011 was due primarily to an increase in transportation customers largely as a result of marketing activity by third party natural gas providers in NJNG's distribution territory, in addition to customers that transferred from residential sales, as noted above. NJNG had 29,883 and 16,472 residential customers and 8,602 and 7,580 commercial customers using its transportation service at June 30, 2011 and 2010, respectively.
NJNG added 4,610 and 3,938 new customers and converted 453 and 441 existing customers to natural gas heat and other services during the nine months ended June 30, 2011 and 2010, respectively. The customer growth represents an estimated annual increase of approximately 0.5 Bcf in sales to firm customers, assuming normal weather and usage, which would contribute approximately $2.4 million annually to utility gross margin.
As a result of NJNG's implementation of the CIP, utility gross margin is no longer linked to customer usage. The CIP eliminates the disincentive to promote conservation and energy efficiency and facilitates normalizing NJNG's utility gross margin recoveries for variances not only due to weather but also for other factors affecting usage, including customer conservation. Recovery of utility gross margin for the non-weather variance through the CIP is limited to the amount of certain gas supply cost savings achieved and is subject to an earnings test, which contains a return on equity component of 10.3 percent.
NJNG's total utility firm gross margin includes the following adjustments related to the CIP mechanism:
Three Months Ended | Nine Months Ended | |||||||||||
June 30, | June 30, | |||||||||||
(Thousands) | 2011 | 2010 | 2011 | 2010 | ||||||||
Weather (1) | $ | 3,421 | $ | 4,565 | $ | 571 | $ | 9,032 | ||||
Usage | 929 | 1,724 | 5,428 | 4,694 | ||||||||
Total | $ | 4,350 | $ | 6,289 | $ | 5,999 | $ | 13,726 |
(1) | Compared with the twenty-year average, weather was 29.4 percent and 39.8 percent warmer-than-normal during three months ended June 30, 2011 and 2010, respectively and 0.4 percent and 7.8 percent warmer-than-normal during the nine months ended June 30, 2011 and 2010, respectively. |
Incentive Programs
To reduce the overall cost of its natural gas supply commitments, NJNG has entered into contracts to sell natural gas to wholesale customers outside its franchise territory when natural gas is not needed for firm system requirements. These Off-system Sales enable NJNG to reduce its overall costs applicable to BGSS customers. NJNG also participates in the Capacity Release market on the interstate pipeline network when the capacity is not needed for its firm system requirements. NJNG retains 15 percent of the utility gross margin from these sales, with 85 percent credited to firm customers through the BGSS.
The FRM program is designed to provide price stability to NJNG's natural gas supply portfolio. The FRM program includes an incentive mechanism designed to encourage the use of financial instruments to economically hedge NJNG's natural gas costs. Gross margin is generated by entering into financial option positions that have a strike price below a published quarterly benchmark, minus premiums and associated fees. NJNG retains 15 percent of the utility gross margin, with 85 percent credited to firm customers through the BGSS.
The Storage Incentive program measures the difference between the actual cost of natural gas injected into storage and a benchmark established with the purchase of a portfolio of futures contracts applicable to the April-through-October natural gas injection season. Gains and losses are shared on an 80 percent and 20 percent basis between customers and NJNG, respectively.
Page 38
New Jersey Resources Corporation
Part I
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (Continued)
Since the current programs expire on October 31, 2011, on April 1, 2011, NJNG filed a letter petition with the BPU for approval of a five-year extension of NJNG's BGSS incentive programs through October 31, 2016. On July 25, 2011, NJNG, the BPU and Rate Counsel executed a Stipulation to extend NJNG's margin-sharing incentive programs for four years through October 31, 2015, under the same terms of its previous agreement with respect to margin-sharing percentages. This agreement also permits NJNG to annually propose a process to evaluate and discuss alternative incentive programs, should performance of the existing incentives or market conditions warrant re-evaluation. BPU approval is expected before the beginning of fiscal 2012.
Utility gross margin generated by NJNG's incentive programs decreased $482,000 during the three months ended June 30, 2011, to $1.5 million compared with $2 million during the three months ended June 30, 2010, due primarily to storage incentive timing of physical injections, partially offset by an increase in capacity release volume.
Utility gross margin generated by NJNG's incentive programs increased $292,000 during the nine months ended June 30, 2011, to $7.7 million compared with $7.4 million during the nine months ended June 30, 2010, due primarily to an increase in capacity release volume, an increase in the FRM program due to increased market opportunities, partially offset by storage incentive timing of physical injections.
Interruptible Revenues
As of June 30, 2011, NJNG serves 43 customers through interruptible transportation and sales services compared with 45 customers as of June 30, 2010. Interruptible customers are those customers whose service can be temporarily halted as they have the ability to utilize an alternate fuel source. Interruptible revenues generally account for less than 1 percent of total utility gross margin.
Operation and Maintenance Expense
Operation and maintenance expense increased $273,000, or 1.1 percent, during the three months ended June 30, 2011, compared with the three months ended June 30, 2010, due primarily to the following:
• | an increase of $300,000 due primarily to higher charitable contributions; |
• | an increase in bad debt expense of $217,000 corresponding to higher customer receivable balances during the three months ended June 30, 2011, in comparison to balances during the prior fiscal year, which were lower as a result of bill credits issued to customers; |
• | an increase in fringe benefits of $189,000 related to pension and health benefit costs due to the decline in the discount rate used to measure plan liabilities, partially offset by a decrease in actual medical claims; |
• | an increase in contractors expenses of $246,000; |
• | an increase in consulting fees of $106,000; partially offset by |
• | a decrease in shared corporate services costs of $323,000, due primarily to lower incentive accruals; and |
• | a decrease in compensation costs of $255,000 due primarily to lower labor and incentive accruals. |
Operation and maintenance expense increased $521,000, or 0.7 percent, during the nine months ended June 30, 2011, compared with the nine months ended June 30, 2010, due primarily to the following:
• | an increase in fringe benefits of $1.3 million related to pension and health benefit costs due to the decline in the discount rate used to measure plan liabilities coupled with an increase in actual medical claims; |
• | an increase in bad debt expense of $1.3 million corresponding to higher customer receivable balances during the nine months ended June 30, 2011, in comparison to balances during the prior fiscal year, which were lower as a result of BGSS refund and bill credits issued to customers; |
Page 39
New Jersey Resources Corporation
Part I
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (Continued)
• | an increase in contractors expense of $528,000; partially offset by |
• | a decrease of $1 million due primarily to lower engineering costs; |
• | a decrease in shared services costs of $961,000 due primarily to lower incentive accruals; |
• | a decrease of $329,000 due primarily to lower legal costs; and |
• | a decrease of $189,000 due primarily to lower charitable contributions. |
Depreciation Expense
Depreciation expense increased $253,000 and $1.3 million, during the three and nine months ended June 30, 2011, respectively compared with the three and nine months ended June 30, 2010, as a result of additional utility plant being placed into service.
Operating Income
Operating income increased $685,000, or 6.2 percent, during the three months ended June 30, 2011, compared with the three months ended June 30, 2010, due primarily to an increase in total utility gross margin of $1.2 million, partially offset by an increase in operation and maintenance expense of $273,000 and depreciation expense of $253,000, as previously discussed.
Operating income increased $7 million, or 5.8 percent, during the nine months ended June 30, 2011, compared with the nine months ended June 30, 2010, due primarily to an increase in total utility gross margin of $8.8 million, partially offset by an increase in depreciation expense of $1.3 million and operation and maintenance expense of $521,000, as previously discussed.
Interest Expense
Interest expense decreased $509,000 and $1.1 million during the three and nine months ended June 30, 2011, respectively, compared with the three and nine months ended June 30, 2010, due primarily to the redemption of a $20 million bond on October 1, 2010.
Net Income
Net income decreased $130,000, or 2.1 percent, to $6 million during the three months ended June 30, 2011, compared with $6.1 million during the three months ended June 30, 2010, due primarily to the effective income tax rate as fiscal 2010 benefited from a non-recurring New Jersey tax rate adjustment.
Net income increased $4.3 million, or 6.1 percent, to $74.4 million during the nine months ended June 30, 2011, compared with $70.1 million during the nine months ended June 30, 2010, due primarily to an increase in operating income and lower interest expense, as discussed above. The increase was partially offset by a decrease in other income due primarily to lower interest associated with MGP recovery as a result of lower interest rates, lower capitalized cost of equity related to AFUDC as a result of increased short-term debt balances in comparison to NJNG's construction work in progress and an increase in income tax expense of $2.8 million correlating to the higher operating income, coupled with a decrease in income tax expense of $509,000 during fiscal 2010 resulting from a non-recurring New Jersey tax rate adjustment.
Energy Services Segment
NJRES is a non-regulated natural gas marketer principally engaged in the optimization of natural gas storage and transportation assets. Through the use of its contracts for natural gas storage and pipeline capacity, NJRES is able to take advantage of pricing differences between geographic locations, commonly referred to as “locational or basis spreads,” and pricing differences across time horizons, commonly referred to as “time spreads.” To capture these price differences, NJRES may enter into contracts for the future delivery and sales of physical natural gas and simultaneously enters into financial derivative contracts to establish an initial financial margin for each of its forecasted physical commodity transactions. The financial derivative contracts serve to protect the cash flows of the transaction from volatility in commodity prices and can include futures, options, and swap contracts, which are all predominantly actively quoted on the NYMEX.
Page 40
New Jersey Resources Corporation
Part I
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (Continued)
Typically, periods of greater price volatility provide NJRES with additional opportunities to generate margin by managing its financial hedge transactions with the intent of further improving the respective time or locational spreads on a forward basis.
The strategies used in capturing the value associated with these price differences include, but are not limited to the following:
• | Storage: NJRES attempts to take advantages of differences in market prices occurring over different time periods (time spreads) as follows: |
◦ | NJRES can purchase gas to inject into storage and concurrently lock in margin with a contract to sell the natural gas at a higher price at a future date; |
◦ | NJRES can purchase a future contract with an early delivery date at a lower price and simultaneously sell another future contract with a later delivery date having a higher price; and |
◦ | NJRES can “borrow” gas from a pipeline or storage operator and repay that gas at a later date, and earn a margin by selling the gas at a later date at a higher price and/or by receiving a fee. |
• | Transportation (Basis): Similarly, NJRES benefits from pricing differences between various receipt and delivery points along a natural gas pipeline as follows: |
◦ | NJRES can utilize its pipeline capacity by purchasing natural gas at a lower price location and transporting to a higher value location. NJRES can enter into a basis swap contract, a financial commodity derivative based on the price of natural gas at two different locations, when it will lead to positive cash flows and margin for NJRES. |
Because NJRES has physical storage and transportation capacity contracts it is able to take advantage of the continuous daily changes in supply and demand in the market areas in which it operates. By utilizing those contracts to assist natural gas marketers, local distribution companies, industrial companies, electric generators, natural gas producers and retail aggregators in managing their gas supply needs, NJRES has opportunities to deliver the gas from storage, purchase flowing gas, or move the gas along a more economically advantageous transportation route than originally planned thereby improving the initial margin. The combination of strategically positioned natural gas storage and transportation assets and physical purchase and sales contracts provides NJRES with a significant amount of arbitrage opportunities that are typically more prevalent during periods of high daily price volatility.
Predominantly all of NJRES' physical purchases and sales of natural gas result in the physical delivery of natural gas. NJRES records its physical commodity contracts at fair value in the Unaudited Condensed Consolidated Balance Sheets with any changes in fair value related to its forward physical sale and purchase contracts recognized as a component of operating revenues and gas purchases, respectively, in the Unaudited Condensed Consolidated Statements of Operations.
The changes in fair value of NJRES' financial derivative instruments, which are financial futures, swaps and option contracts are also recognized in the Unaudited Condensed Consolidated Statements of Operations, as a component of gas purchases.
NJRES' financial and physical contracts will result, over time, in earning a gross margin on the entire transaction. For financial reporting purposes under GAAP, the change in fair value associated with derivative instruments used to economically hedge these transactions are recorded as a component of gas purchases in the Unaudited Condensed Consolidated Statements of Operations during the duration of the financial instrument or commodity contract. These changes in fair value are referred to as unrealized gains and losses. In other instances, certain financial contracts designed to economically fix or hedge the price of natural gas that is purchased and placed into storage, to be sold at a later date, settle and result in realized gains, which are also recorded as a component of gas purchases in the Unaudited Condensed Consolidated Statements of Operations.
These unrealized gains or losses from the change in fair value of unsettled financial instruments and physical commodity contracts, or realized gains or losses related to financial instruments that economically hedge natural gas inventory that has not been sold as part of a planned transaction, cause large variations in the reported gross margin and earnings of NJRES. NJRES will continue to earn the gross margin established at inception of the transaction over the duration of the forecasted transaction and may be able to capitalize on events in the marketplace that enable it to increase the initial margin; however, gross margin or earnings during periods prior to the delivery of the natural gas will not reflect the underlying economic result.
Page 41
New Jersey Resources Corporation
Part I
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (Continued)
NJRES recognizes its demand charges, which represent the right to use natural gas pipeline and storage capacity assets of a third-party, over the term of the related natural gas pipeline or storage contract. The term of these contracts vary from less than one year to ten years.
Operating Results
NJRES' financial results are summarized as follows:
Three Months Ended | Nine Months Ended | |||||||||||
June 30, | June 30, | |||||||||||
(Thousands) | 2011 | 2010 | 2011 | 2010 | ||||||||
Operating revenues | $ | 500,413 | $ | 364,800 | $ | 1,504,262 | $ | 1,207,166 | ||||
Gas purchases (including demand charges) | 483,017 | 393,166 | 1,461,009 | 1,125,160 | ||||||||
Gross margin | 17,396 | (28,366 | ) | 43,253 | 82,006 | |||||||
Operation and maintenance expense | 4,055 | 3,268 | 10,535 | 10,246 | ||||||||
Depreciation and amortization | 15 | 37 | 46 | 136 | ||||||||
Other taxes | 255 | 50 | 850 | 950 | ||||||||
Operating income | 13,071 | (31,721 | ) | 31,822 | 70,674 | |||||||
Other income | 1 | 7 | 9 | 11 | ||||||||
Interest expense, net | 193 | 425 | 792 | 917 | ||||||||
Income tax provision (benefit) | 1,949 | (13,316 | ) | 8,632 | 25,506 | |||||||
Net income (loss) | $ | 10,930 | $ | (18,823 | ) | $ | 22,407 | $ | 44,262 |
As of June 30, 2011, NJRES' portfolio of financial derivative instruments was comprised of:
• | 26.2 Bcf of net short futures contracts and fixed swap positions, and; |
• | 3.5 Bcf of net long basis swap positions. |
As of June 30, 2010, NJRES' portfolio of financial derivative instruments was comprised of:
• | 35.0 Bcf of net short futures contracts and fixed swap positions, and; |
• | 31.4 Bcf of net short basis swap positions. |
Gross Margin
NJRES' gross margin is a non-GAAP financial measure defined as natural gas revenues less natural gas purchases (including demand charges), and may not be comparable to the definition of gross margin used by others in the natural gas distribution business and other industries. Gross margin during the three months ended June 30, 2011, was higher by approximately $45.8 million compared with the three months ended June 30, 2010, due primarily to realized and unrealized gains during fiscal 2011 compared to realized and unrealized losses during fiscal 2010. During the nine months ended June 30, 2011, gross margin was lower by approximately $38.8 million compared with the nine months ended June 30, 2010, due primarily to an increase in unrealized losses during fiscal 2011 compared to fiscal 2010, partially offset by higher realized gains year-over-year.
NJRES had unrealized gains (losses) of $4.6 million and $(26.1) million during the three months ended June 30, 2011 and 2010, respectively, and unrealized losses of $(53.4) million and $(2.8) million during the nine months ended June 30, 2011 and 2010, respectively, relating to physical and financial contracts that have not yet settled. These unrealized amounts represent the change in price of natural gas from the original hedge price compared with the market price of natural gas at each reporting date. When transactions are settled any previously recognized unrealized amounts related to these transactions will be realized.
NJRES also had realized gains (losses) of $12.3 million and $(10.2) million during the three months ended June 30, 2011 and 2010, respectively, and realized gains of $58.2 million and $26.6 million during the nine months ended June 30, 2011 and 2010, respectively, relating to the effects of economic hedging related to natural gas inventory. The realized gains (losses) pertain to the settlement of certain purchased futures and fixed swap contracts, which economically hedge planned natural gas purchases. The gains incurred during the three months ended June 30, 2011, resulted from favorable settlement prices compared with the prior year. The increase in gains incurred during the nine months ended June 30, 2011, resulted from more favorable settlement prices compared with the prior year.
Page 42
New Jersey Resources Corporation
Part I
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (Continued)
As these financial contracts settle, the physical gas is purchased and injected into storage. These physical gas injections and the associated financial hedges are part of the NJRES' business strategy to subsequently sell the natural gas from storage in the future. The realized amounts are a component of the anticipated financial margin associated with the overall strategy, and as a result of certain accounting requirements, are recognized in current earnings and result in a timing difference until the related gas is sold at which time, NJRES will realize the entire margin on the transaction.
In addition, there was a decrease in realized margin associated with physical sale of natural gas during the three and nine months ended June 30, 2011, as described further in the discussion of financial margin in the Non-GAAP measures section.
Non-GAAP measures
Management of the Company uses non-GAAP measures, noted as ��financial margin” and “net financial earnings”, when evaluating the operating results of NJRES. Since NJRES economically hedges its natural gas purchases and sales with derivative instruments, management uses these measures to compare NJRES' results against established benchmarks and earnings targets as it eliminates the impact of volatility to GAAP earnings associated with the derivative instruments. Volatility can occur as a result of timing differences surrounding the recognition of certain gains and losses. These timing differences can impact GAAP earnings in two ways:
• | Unrealized gains and losses on derivatives are recognized in reported earnings in periods prior to sales of physical gas inventory flows; and |
• | Settlement of economic hedges that result in realized gains and losses prior to when the related physical gas inventory movements occur. |
Net financial earnings and net financial margin are measures of the earnings and margin based on eliminating these timing differences to effectively match the earnings effects of the economic hedges with the physical sale of gas. Consequently, to reconcile from GAAP to both financial margin and net financial earnings, current period unrealized gains and losses on the derivatives are excluded as a reconciling item. Additionally, the effects of economic hedging on the value of our natural gas in storage is also included in current period net loss, however financial margin and net financial earnings include only realized gains and losses related to natural gas sold out of inventory, effectively matching the full earnings effects of the derivatives with realized margins on physical gas flows.
Management views financial margin and net financial earnings as more representative of the overall expected economic result. To the extent that there are unanticipated changes in the markets or to the effectiveness of the economic hedges, NJRES' non-GAAP results can be different than was originally planned at the beginning of the transaction.
The following table is a computation of financial margin of NJRES:
Three Months Ended | Nine Months Ended | |||||||||||
June 30, | June 30, | |||||||||||
(Thousands) | 2011 | 2010 | 2011 | 2010 | ||||||||
Operating revenues | $ | 500,413 | $ | 364,800 | $ | 1,504,262 | $ | 1,207,166 | ||||
Less: Gas purchases | 483,017 | 393,166 | 1,461,009 | 1,125,160 | ||||||||
Add: | ||||||||||||
Unrealized (gain) loss on derivative instruments and related instruments | (4,612 | ) | 26,068 | 53,393 | 2,833 | |||||||
Effects of economic hedging related to natural gas inventory | (12,335 | ) | 10,245 | (58,178 | ) | (26,641 | ) | |||||
Financial margin | $ | 449 | $ | 7,947 | $ | 38,468 | $ | 58,198 |
Page 43
New Jersey Resources Corporation
Part I
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (Continued)
A reconciliation of operating income, the closest GAAP financial measurement, to the financial margin of NJRES is as follows:
Three Months Ended | Nine Months Ended | |||||||||||
June 30, | June 30, | |||||||||||
(Thousands) | 2011 | 2010 | 2011 | 2010 | ||||||||
Operating income (loss) | $ | 13,071 | $ | (31,721 | ) | $ | 31,822 | $ | 70,674 | |||
Add: | ||||||||||||
Operation and maintenance expense | 4,055 | 3,268 | 10,535 | 10,246 | ||||||||
Depreciation and amortization | 15 | 37 | 46 | 136 | ||||||||
Other taxes | 255 | 50 | 850 | 950 | ||||||||
Subtotal - Gross margin | 17,396 | (28,366 | ) | 43,253 | 82,006 | |||||||
Add: | ||||||||||||
Unrealized (gain) loss on derivative instruments and related instruments | (4,612 | ) | 26,068 | 53,393 | 2,833 | |||||||
Effects of economic hedging related to natural gas inventory | (12,335 | ) | 10,245 | (58,178 | ) | (26,641 | ) | |||||
Financial margin | $ | 449 | $ | 7,947 | $ | 38,468 | $ | 58,198 |
A reconciliation of NJRES' net (loss) income to net financial earnings is as follows:
Three Months Ended | Nine Months Ended | |||||||||||
June 30, | June 30, | |||||||||||
(Thousands) | 2011 | 2010 | 2011 | 2010 | ||||||||
Net income (loss) | $ | 10,930 | $ | (18,823 | ) | $ | 22,407 | $ | 44,262 | |||
Add: | ||||||||||||
Unrealized (gain) loss on derivative instruments and related instrument, net of taxes | (2,917 | ) | 16,281 | 33,761 | 1,952 | |||||||
Effects of economic hedging related to natural gas inventory, net of taxes | (7,800 | ) | 5,878 | (36,787 | ) | (16,867 | ) | |||||
Net financial earnings | $ | 213 | $ | 3,336 | $ | 19,381 | $ | 29,347 |
Financial margin decreased $7.5 million to $449,000 during the three months ended June 30, 2011, and decreased $19.7 million to $38.5 million during the nine months ended June 30, 2011 due primarily to a reduction in volatility in NJRES' market area. Exploration and production of shale gas in the Northeastern regions has contributed to a compression in natural gas prices and a general decrease in opportunities to generate margin from the optimization of transportation and storage assets. Overall the fundamental change in the supply of shale gas and related market volatility is expected to lower NJRES' financial margin and net financial earnings contribution to between 10 and 20 percent of consolidated net financial earnings during fiscal 2011 from a larger share in fiscal 2010.
Operation and Maintenance Expense
Operation and maintenance expense increased $787,000, or 24.1 percent, during the three months ended June 30, 2011, compared with the three months ended June 30, 2010, due primarily to higher consulting fees.
Operation and maintenance expense increased $289,000, or 2.8 percent, during the nine months ended June 30, 2011, compared with the nine months ended June 30, 2010, due primarily to an increase in salaries and consulting fees offset by a decrease in shared corporate services costs and fringe benefits.
Future results are subject to NJRES' ability to maintain and expand its wholesale marketing activities and are contingent upon many other factors, including an adequate number of appropriate counterparties, volatility in the natural gas market, availability of storage arbitrage opportunities, sufficient liquidity in the energy trading market, supply and demand for natural gas and continued access to the capital markets.
Page 44
New Jersey Resources Corporation
Part I
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (Continued)
Net Financial Earnings
Net financial earnings decreased $3.1 million and $10 million during the three and nine months ended June 30, 2011, respectively, compared with the three and nine months ended June 30, 2010, due primarily to lower financial margin, which has been impacted by a general reduction in volatility in NJRES' market area, as previously described, partially offset by an income tax benefit of $4.3 million related to a tax refund expected from the State of New Jersey that was recorded during the third fiscal quarter. After fees and federal income taxes, the net impact was $2.4 million. See Note 12. Income Taxes for a more detailed discussion of the refund.
Midstream Assets Segment
Operating Results
The consolidated financial results of Midstream Assets are summarized as follows:
Three Months Ended | Nine Months Ended | |||||||||||
June 30, | June 30, | |||||||||||
(Thousands) | 2011 | 2010 | 2011 | 2010 | ||||||||
Equity in earnings of affiliates | $ | 3,891 | $ | 2,538 | $ | 11,871 | $ | 10,261 | ||||
Operation and maintenance expense | $ | 127 | $ | 137 | $ | 402 | $ | 586 | ||||
Interest expense, net | $ | 578 | $ | 153 | $ | 1,751 | $ | 1,379 | ||||
Net income | $ | 1,847 | $ | 1,828 | $ | 5,705 | $ | 5,218 |
During the three and nine months ended June 30, 2011, equity in earnings increased $1.4 million and $1.6 million, respectively, due to higher earnings at Steckman Ridge and Iroquois compared with the three and nine months ended June 30, 2010. Equity in earnings from Steckman Ridge is driven by storage revenues, which are based on market rates. Equity in earnings from Iroquois is driven by the underlying performance of natural gas transportation through its existing pipeline, which is based on FERC regulated tariffs. The contributions from Iroquois and Steckman Ridge are summarized as follows:
Three Months Ended | Nine Months Ended | |||||||||||
June 30, | June 30, | |||||||||||
(Thousands) | 2011 | 2010 | 2011 | 2010 | ||||||||
Iroquois | $ | 1,205 | $ | 1,257 | $ | 3,832 | $ | 3,510 | ||||
Steckman Ridge | 2,686 | 1,281 | 8,039 | 6,751 | ||||||||
Total equity in earnings | $ | 3,891 | $ | 2,538 | $ | 11,871 | $ | 10,261 |
Operation and maintenance expense had slight decreases for the three and nine months ended June 30, 2011, compared with the three and nine months ended June 30, 2010, due primarily to decreased shared corporate services costs. Interest expense increased for the three and nine months ended June 30, 2011, compared with the three and nine months ended June 30, 2010.
Net income increased $19,000 and $487,000 during the three and nine months ended June 30, 2011, respectively, compared with the three and nine months ended June 30, 2010, due primarily to the increase in equity in earnings.
Clean Energy Ventures Segment
Operating Results
During the fourth quarter of fiscal 2010, NJRCEV began entering into agreements to install, operate and maintain solar equipment on commercial property. As of June 30, 2011, certain of these projects have been placed in service and others have commenced and are expected to be completed and operational during the fourth quarter of fiscal 2011.
Page 45
New Jersey Resources Corporation
Part I
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (Continued)
The consolidated financial results of CEV are summarized as follows:
Three Months Ended | Nine Months Ended | |||||||||||
June 30, | June 30, | |||||||||||
(Thousands) | 2011 | 2010 | 2011 | 2010 | ||||||||
Operating revenue | $ | 328 | $ | — | $ | 328 | $ | — | ||||
Operation and maintenance expense | $ | 814 | $ | — | $ | 2,215 | $ | — | ||||
Income tax (benefit) | $ | (898 | ) | $ | — | $ | (7,608 | ) | $ | — | ||
Net income | $ | 259 | $ | — | $ | 5,484 | $ | — |
Operating revenue generated during the three and nine months ended June 30, 2011, consists primarily of the sale of SRECs that have been generated from the solar projects that have been placed in service.
Operation and maintenance expense during the three and nine months ended June 30, 2011, consisted primarily of start-up costs including compensation, shared corporate services costs, consulting costs and other administrative expenses.
Income tax benefit during the three and nine months ended June 30, 2011, includes the actual ITC associated with solar projects that have been completed as of June 30, 2011, as well as an adjustment of $538,000 and $4.5 million, respectively, for ITC based on solar projects that NJR believes are probable of being completed and available for use by the end of the current fiscal year. The projects that NJR believes are probable of being available for use by September 30, 2011, and the related estimated ITC are evaluated at the end of each reporting period and are subject to change based on management's assessments of various contractual and logistical factors. For a more detailed discussion of risks associated with the tax adjustment, see Part II, Item 1A, Risk Factors.
Net income during the three and nine months ended June 30, 2011, includes the ITC, partially offset by operation and maintenance expense, as discussed above.
Retail and Other Operations
Operating Results
The consolidated financial results of Retail and Other summarized as follows:
Three Months Ended | Nine Months Ended | |||||||||||
June 30, | June 30 | |||||||||||
(Thousands) | 2011 | 2010 | 2011 | 2010 | ||||||||
Operating revenues | $ | 10,951 | $ | 10,058 | $ | 26,903 | $ | 19,803 | ||||
Operation and maintenance expense | $ | 7,934 | $ | 7,862 | $ | 23,147 | $ | 22,168 | ||||
Net income (loss) | $ | 1,401 | $ | 725 | $ | 913 | $ | (3,481 | ) |
Operating revenue increased $893,000, or 8.9 percent, during the three months ended June 30, 2011, to $11 million compared with $10.1 million during the three months ended June 30, 2010. The improvement was due primarily to an increase of $1.5 million at NJRHS due primarily to increased installations and service contracts, offset by unrealized gains associated with financial derivatives at NJR Energy of $695,000 during fiscal 2010 that did not recur during the three months ended June 30, 2011.
Operating revenue increased $7.1 million, or 35.9 percent, during the nine months ended June 30, 2011, to $26.9 million compared with $19.8 million during the nine months ended June 30, 2010. The improvement was due primarily to an increase of $3.9 million at NJRHS due primarily to increased installations and service contracts, in addition to unrealized (losses) of $(3.1) million at NJR Energy during fiscal 2010 that did not recur during the nine months ended June 30, 2011.
Operation and maintenance expense remained relatively flat during the three months ended June 30, 2011 and 2010. Operation and maintenance expense increased $979,000 during the nine months ended June 30, 2011, as compared with the same periods in fiscal 2010, due primarily to NJRHS' increased compensation cost and advertising expense, partially offset by decreased shared corporate services costs.
Page 46
New Jersey Resources Corporation
Part I
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (Continued)
Net income during the three and nine months ended June 30, 2011, increased $676,000 and $4.4 million, respectively, compared with the three and nine months ended June 30, 2010, due primarily to increased operating revenue, as discussed above and the ITC generated by the residential solar pilot program, partially offset by increased operation and maintenance expense, as discussed above, as well as an increase in depreciation expense. Retail and other solar projects generated $243,000 and $569,000 of net income during the three and nine months ended June 30, 2011, respectively.
Non-GAAP measures
Additionally, management of the Company uses the non-GAAP measure “net financial earnings”, when viewing the results of NJR Energy to monitor the operational results without the impact of unsettled derivative instruments. NJR Energy's financial derivative expired during fiscal 2010.
A reconciliation of Net loss to Net financial loss, a non-GAAP measure, of Retail and other operations is as follows:
Three Months Ended | Nine Months Ended | |||||||||||
June 30, | June 30, | |||||||||||
(Thousands) | 2011 | 2010 | 2011 | 2010 | ||||||||
Net income (loss) | $ | 1,401 | $ | 725 | $ | 913 | $ | (3,481 | ) | |||
Add: | ||||||||||||
Unrealized (gain) loss on derivative instruments, net of taxes | — | (411 | ) | — | 1,840 | |||||||
Net financial earnings (loss) | $ | 1,401 | $ | 314 | $ | 913 | $ | (1,641 | ) |
Net financial earnings increased $1.1 million and $2.6 million during the three and nine months ended June 30, 2011, respectively, compared with the three and nine months ended June 30, 2010, due primarily to an increase in operating revenue and ITC generated from solar projects associated with the residential pilot program, decreased income taxes as a result of a tax charge that occurred during the nine months ended June 30, 2010, in the amount of approximately $591,000 related to a change in the deductibility of federal subsidies associated with Medicare Part D, partially offset by an increase in operations and maintenance expense and depreciation, as discussed above.
Liquidity and Capital Resources
NJR's objective is to maintain a consolidated capital structure that reflects the different characteristics of each business segment and business operations and provides adequate financial flexibility for accessing capital markets as required.
NJR's consolidated capital structure was as follows:
June 30, 2011 | September 30, 2010 | |||
Common stock equity | 58 | % | 55 | % |
Long-term debt | 31 | 32 | ||
Short-term debt | 11 | 13 | ||
Total | 100 | % | 100 | % |
Common stock equity
NJR satisfies its external common equity requirements, if any, through issuances of its common stock, including the proceeds from stock issuances under its Automatic Dividend Reinvestment Plan (DRP) and proceeds from the exercise of options issued under the Company's long-term incentive program. The DRP allows NJR, at its option, to use shares purchased on the open market, treasury shares or newly issued shares.
In 1996, the NJR Board of Directors (Board) authorized the Company to implement a share repurchase program, which has been expanded several times since the inception of the program. On January 27, 2010, the Board of Directors authorized an increase in the number of shares of NJR common stock authorized for repurchase under NJR's Share Repurchase Plan by 2 million shares to a total of 8.8 million shares. As of June 30, 2011, the Company repurchased a total of 7.3 million of those shares and may repurchase an additional 1.5 million shares under the approved program.
Page 47
New Jersey Resources Corporation
Part I
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (Continued)
Debt
NJR and its unregulated subsidiaries generally rely on cash flows generated from operating activities and utilization of committed credit facilities to provide liquidity to meet working capital and external debt-financing requirements. NJR may from time to time look to access the capital markets to fund long-life assets.
NJR believes that its existing borrowing availability and cash flow from operations will be sufficient to satisfy its and its subsidiaries' working capital, capital expenditures and dividend requirements for the foreseeable future. NJR, NJNG and NJRES currently anticipate that its financing requirements for the next twelve months will be met primarily through the issuance of short-term debt, meter sale-leasebacks, proceeds from the Company's DRP and may also include the issuance of long-term debt depending on timing of capital investments.
NJR believes that as of June 30, 2011, NJR and NJNG were, and currently are, in compliance with all debt covenants.
Long-Term Debt
NJR currently has $50 million of 6.05 percent debt, issued through the private placement market, maturing in September 2017.
On October 1, 2010, upon maturity, NJNG redeemed its $20 million, 6.88 percent Series CC First Mortgage bonds. As of June 30, 2011, NJNG had $172.8 million in various secured fixed-rate debt remaining, with maturities ranging from 2018 to 2040, and $60 million of 4.77 percent unsecured senior notes, maturing in March 2014.
In addition, NJNG is obligated with respect to loan agreements securing six series of variable rate bonds totaling $97 million of variable-rate debt backed by securities issued by the New Jersey Economic Development Authority (EDA). The EDA bonds are commonly referred to as auction-rate securities (ARS) and have an interest rate reset every seven or thirty-five days, depending upon the applicable series. On those dates, an auction is held for the purposes of determining the interest rate of the securities. The interest rate associated with NJNG's variable-rate debt are based on the rates of the related EDA ARS. As of June 30, 2011, all of the auctions surrounding the EDA ARS have failed, resulting in those bonds bearing interest at their maximum rates, as defined as the lesser of (i) 175 percent of thirty-day London inter-bank offered rate (LIBOR) or (ii) 10 to 12 percent per annum, as applicable to such series of ARS. While the failure of the ARS auctions does not signify or constitute a default on NJNG, the EDA ARS does impact NJNG's borrowing costs of the variable-rate debt. At June 30, 2011, the thirty-day LIBOR rate was 0.19 percent. NJNG had a weighted average interest rate of 0.33 percent at both June 30, 2011 and September 30, 2010. LIBOR rates are set by market forces and as a result subject to unforeseen changes. A 100 basis point change in the thirty-day LIBOR average interest rate would have caused a change in interest expense for these variable rate bonds of approximately $1.3 million during the nine months ended June 30, 2011.
There can be no assurance that the EDA ARS will have enough market liquidity to avoid failed auctions in the future, which could potentially have an adverse impact on NJNG's borrowing costs if LIBOR rates increase. NJNG is currently planning a refinancing of the EDA ARS, replacing them with variable rate demand bonds to be issued by the EDA which, subject to closing and market conditions, is expected to be completed by the end of fiscal 2011. NJNG cannot assure that the alternative sources of financing can be implemented in a timely manner to completely mitigate sudden increases in NJNG's borrowing costs.
Short-Term Debt
NJR uses its short-term borrowings primarily to finance its share repurchases, to satisfy NJRES' short-term liquidity needs and to finance, on an initial basis, unregulated investments. NJRES' use of high-injection, high-withdrawal storage facilities and anticipated pipeline park-and-loan arrangements, combined with related economic hedging activities in the volatile wholesale natural gas market, create significant short-term cash requirements.
NJNG satisfies its debt needs by issuing short- and long-term debt based upon its own financial profile. The seasonal nature of NJNG's operations creates large short-term cash requirements, primarily to finance natural gas purchases and customer accounts receivable. NJNG obtains working capital for these requirements, and for the temporary financing of construction and MGP remediation expenditures and energy tax payments, through the issuance of commercial paper and short-term bank loans.
Page 48
New Jersey Resources Corporation
Part I
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (Continued)
As of June 30, 2011, NJR and NJNG had credit facilities totaling $325 million and $200 million, respectively, as described below, with $187 million and $200 million, respectively, available under the facilities. Due to the seasonal nature of natural gas prices and demand, NJR and NJNG's short-term borrowings tend to peak in the winter months.
Short-term borrowings were as follows:
Three Months Ended | Nine Months Ended | |||||
($ in thousands) | June 30, 2011 | |||||
NJR | ||||||
Notes payable to banks: | ||||||
Balance at end of period | $ | 138,000 | $ | 138,000 | ||
Weighted average interest rate at end of period | 0.52 | % | 0.52 | % | ||
Average balance for the period | $ | 146,736 | $ | 192,101 | ||
Weighted average interest rate for average balance | 0.53 | % | 0.56 | % | ||
Month end maximum for the period | $ | 153,100 | $ | 284,125 | ||
NJNG | ||||||
Commercial paper: | ||||||
Balance at end of period | $ | — | $ | — | ||
Weighted average interest rate at end of period | — | % | — | % | ||
Average balance for the period | $ | — | $ | 25,233 | ||
Weighted average interest rate for average balance | — | % | 0.14 | % | ||
Month end maximum for the period | $ | — | $ | 71,000 |
NJR has a $325 million, revolving unsecured credit facility expiring December 2012 (NJR Credit Facility), which permits the borrowing of revolving loans and swing loans, as well as the issuance of letters of credit. Swing loans are loans made available on a same-day basis for an aggregate principal amount of up to $50 million and repayable in full within a maximum of seven days of borrowing. The credit facility also permits an increase to the facility, from time to time, with the existing or new lenders, in a minimum of $5 million increments up to a maximum $100 million at the lending banks discretion. Borrowings under the facility are conditional upon compliance with a maximum leverage ratio, as defined in the credit facility, of not more than 0.65 to 1.00 at any time. In addition, certain of NJR's non-regulated subsidiaries have guaranteed to the lenders all of NJR's obligations under the credit facility. Depending on borrowing levels and credit ratings, NJR's interest rate can either be, at its discretion, the LIBOR or the Federal Funds Open Rate plus an applicable spread and facility fee. During the nine months ended June 30, 2011, NJR's average interest rate was 0.56 percent, resulting in interest expense of $817,900. Based on average borrowings under the facility of $192.1 million during the period, a 100 basis point change in the underlying average interest rate would have caused a change in interest expense of approximately $1.5 million during the nine months ended June 30, 2011.
On March 18, 2011, NJR, as borrower, and certain of the Company's unregulated subsidiaries, as guarantors, entered into an amendment to the NJR Credit Facility, to allow the Company increased flexibility to issue senior indebtedness. The amendment allows the Company to issue additional indebtedness in respect of senior notes so long as such additional indebtedness (a)(i) is unsecured, (ii) is on terms not materially more restrictive than the Company's $50 million Note Purchase Agreement dated as of September 24, 2007, unless the Company irrevocably offers to enter into an amendment to the NJR Credit Facility to add such terms to the NJR Credit Facility, (iii) has a maturity date no earlier than 180 days after the expiration date of the NJR Credit Facility and (iv) has an interest rate not materially in excess of prevailing rates at such time for like transactions with a borrower of comparable credit rating to the Company, and (b) when taken together with certain other indebtedness permitted under the NJR Credit Facility shall not exceed 65 percent of the sum of the Company's consolidated total indebtedness plus its consolidated shareholders' equity, as those terms are defined in the NJR Credit Facility.
On January 11, 2011, NJR entered into an agreement for an additional $50 million unsecured committed credit line, which was terminated by the Company on February 22, 2011. The additional credit line, was put in place primarily to provide additional working capital to NJRES to meet any potential margin calls that could have arisen in NJRES' normal course of business.
Page 49
New Jersey Resources Corporation
Part I
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (Continued)
On May 12, 2011, NJR entered into an uncommitted $100 million private placement shelf note agreement, which will, subject to the terms and conditions set forth therein, allow NJR to issue senior notes from time to time during a two-year period ending May 10, 2013. On June 30, 2011, NJR entered into an uncommitted $75 million private placement shelf note agreement which will, subject to the terms and conditions set forth therein, allow NJR to issue senior notes from time to time during a three-year period expiring June 30, 2014. The terms and conditions of the notes issued under each of the shelf note agreements (collectively, the Facilities), including interest rates and maturity dates, will be agreed upon at the time of each note issuance. Notes issued under the Facilities will be guaranteed by certain unregulated subsidiaries of the Company and will be unsecured, subject to the right of the noteholders to receive certain equal and ratable collateral under the limited circumstances specified in the Facilities The proceeds of any issuance under the Facilities will be used for general corporate purposes, including working capital and capital expenditures.
The Facilities each contain customary representations and warranties for transactions of this type. The Facilities also each contain customary events of default and certain covenants which will limit NJR's ability beyond agreed upon thresholds, to, among other things: (i) incur additional debt (including a covenant which limits the amount of consolidated total debt of NJR at the end of a fiscal quarter to 65 percent of the consolidated total capitalization of NJR, as those terms are defined in each Facility and a covenant limiting priority debt to 20 percent of NJR's consolidated total capitalization, as those terms are defined in each Facility); (ii) incur liens; (iii) make dispositions of assets; (iv) enter into transactions with affiliates; and (v) merge, consolidate, transfer, sell or lease all or substantially all of the NJR's assets. These covenants are subject to a number of important exceptions and qualifications set forth in the Facilities. As of June 30, 2011, NJR had no borrowings outstanding under these agreements.
As of June 30, 2011, NJR has five letters of credit outstanding totaling $8.4 million. Three which total $7.1 million are on behalf of NJRES, one for $675,000 is on behalf of CR&R and one for $711,000 is on behalf of NJRCEV. These letters of credit reduce the amount available under NJR's committed credit facility by the same amount. NJR does not anticipate that these letters of credit will be drawn upon by the counterparties, and they will be renewed as necessary.
Two of NJRES' letters of credit are used to secure the purchase and/or sale of natural gas; one expires on December 31, 2011, and the other expires on February 1, 2012. The other NJRES letter of credit is used for margin requirements for natural gas transactions and expires on December 31, 2011. CR&R's letter of credit is in place to support development activities and expiries on December 3, 2011. NJRCEV's letter of credit is in place to secure construction of a ground-mounted solar project and expires on June 22, 2012.
NJNG has a $200 million unsecured committed credit facility expiring December 2012, which permits the borrowing of revolving loans and swing loans, as well as the issuance of letters of credit. It also permits an increase to the facility, from time to time, with the existing or new lenders, in a minimum of $10 million increments up to a maximum of $50 million at the lending banks' discretion. Depending on borrowing levels and credit ratings, NJNG's interest rate can either be, at its discretion, based upon Prime Rate, the Federal Funds Open Rate or the Euro-Rate, in each case, plus an applicable spread and facility fee. In addition, borrowings under NJNG's credit facility are conditioned upon compliance with a maximum leverage ratio, as defined in the credit facility, of not more than 0.65 to 1.00 at any time and a minimum interest coverage ratio, as defined in the credit facility, of not less than 2.50 to 1.00. During the nine months ended June 30, 2011, NJNG's average interest rate was 0.14 percent, resulting in interest expense of $50,300. Based on average borrowings under the facility of $25.2 million during the period, a 100 basis point change in the underlying average interest rate would have caused a change in interest expense of approximately $193,000 during the nine months ended June 30, 2011.
Neither NJNG nor its assets are obligated or pledged to support the NJR facility.
Sale-Leaseback
NJNG received approximately $5.9 million and $4.9 million in December 2010 and 2009, respectively, related to the sale-leaseback of a portion of its gas meters.
Page 50
New Jersey Resources Corporation
Part I
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (Continued)
Contractual Obligations
The following table is a summary of NJR, NJNG and NJRES contractual cash obligations and financial commitments and their applicable payment due dates as of June 30, 2011:
Up to | 2-3 | 4-5 | After | ||||||||||||
(Thousands) | Total | 1 Year | Years | Years | 5 Years | ||||||||||
Long-term debt (1) | $ | 510,804 | $ | 15,488 | $ | 90,977 | $ | 24,537 | $ | 379,802 | |||||
Capital lease obligations (1) | 77,316 | 13,728 | 19,265 | 17,620 | 26,703 | ||||||||||
Operating leases (1) | 6,775 | 2,062 | 2,559 | 820 | 1,334 | ||||||||||
Short-term debt | 138,000 | 138,000 | — | — | — | ||||||||||
New Jersey Clean Energy Program (1) | 21,448 | 14,725 | 6,723 | — | — | ||||||||||
Construction obligations | 125,892 | 60,292 | 65,600 | — | — | ||||||||||
Accelerated Infrastructure Programs (AIP I, AIP II) | 60,501 | 46,451 | 14,050 | — | — | ||||||||||
Remediation expenditures (2) | 201,600 | 23,600 | 53,900 | 14,000 | 110,100 | ||||||||||
Natural gas supply purchase obligations-NJNG | 47,737 | 47,737 | — | — | — | ||||||||||
Demand fee commitments-NJNG | 658,172 | 105,443 | 208,279 | 103,592 | 240,858 | ||||||||||
Natural gas supply purchase obligations-NJRES | 685,925 | 556,729 | 129,196 | — | — | ||||||||||
Demand fee commitments-NJRES | 203,768 | 83,121 | 68,688 | 27,478 | 24,481 | ||||||||||
Total contractual cash obligations | $ | 2,737,938 | $ | 1,107,376 | $ | 659,237 | $ | 188,047 | $ | 783,278 |
(1) | These obligations include an interest component, as defined under the related governing agreements or in accordance with the applicable tax statute. |
(2) | Expenditures are estimated. |
NJR does not expect to be required to make additional contributions to fund its pension plans over the next three fiscal years based on current actuarial assumptions; however, funding requirements are uncertain and can depend significantly on changes in actuarial assumptions, returns on plan assets and changes in the demographics of eligible employees and covered dependents. In addition, as in the past, NJR may elect to make contributions in excess of the minimum required amount to the plans. NJR made a discretionary contribution of $4.9 million to the pension plans in October 2010. It is anticipated that the annual funding level to the OPEB plans will range from $5.5 million to $6.6 million annually over the next five years. Additional contributions may vary based on market conditions and various assumptions.
As of June 30, 2011, there were NJR guarantees covering approximately $408.4 million of natural gas purchases and demand fee commitments of NJRES and NJNG included in natural gas supply purchase obligations above, not yet reflected in Accounts payable on the Unaudited Condensed Consolidated Balance Sheet.
As of June 30, 2011, NJR had cash investments of $126.8 million in Steckman Ridge, excluding capitalized interest and other direct costs of $7.7 million, and has received cash distributions of $16 million. Should there be additional construction at the facility to improve performance, NJR would be obligated to fund up to an additional $5.7 million for a total of $132.5 million.
Included in the investment in Steckman Ridge are loans including accrued interest through April 2009 in the amount of $70.4 million as of June 30, 2011. NJR, as part of its funding commitment is committed to fund up to a total of $82.5 million in loans. The principal balance of the loans are due December 31, 2017, and can be prepaid at the option of Steckman Ridge. The principal amount of the loans accrue interest at a rate of LIBOR plus 0.95 percent, which resets quarterly.
In conjunction with NJR's goal to promote clean energy, NJR has entered into various agreements to install solar equipment involving both residential and commercial projects. NJR expects capital expenditures related to the purchase and installation of the equipment associated with these contracts to be approximately $70 and $80 million incurred through September 30, 2011, of which $77.6 million has been either committed or spent. Capital expenditures in fiscal 2012 are expected to be $65.6 million. The capital expenditures related to these energy projects are subject to a variety of factors, including logistics associated with the start-up of residential and commercial solar projects, such as timing of construction schedules, the permitting and regulatory process and any delays related to electric grid interconnection, which may affect our ability to commence operations at these projects on a timely basis or, at all.
Page 51
New Jersey Resources Corporation
Part I
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (Continued)
NJNG's total capital expenditures are estimated at $108.2 million and $116.1 million in fiscal 2011 and 2012, respectively, and consist primarily of its construction program to support customer growth, maintenance of its distribution and transmission system and replacement needed under pipeline safety regulations. Capital expenditures in fiscal 2011 include an estimated $26 million related to AIP I construction costs and $11 million related to AIP II. As of June 30, 2011, NJNG has incurred $24.9 million related to the AIP I program and $789,000 related to AIP II during fiscal 2011 and effective October 1, 2010, increased base rate revenue to recover the costs by approximately $4.2 million, based on expenditures incurred through August 31, 2010.
Off-Balance-Sheet Arrangements
The Company does not have any off-balance-sheet arrangements.
Cash Flow
Operating Activities
As presented in the Consolidated Statements of Cash Flows, cash flow from operating activities totaled $227.2 million during the nine months ended June 30, 2011, compared with $155.9 million during the nine months ended June 30, 2010. NJR employs the indirect method when preparing its Consolidated Statement of Cash Flows. Net income is adjusted for any non-cash items, such as depreciation, accruals and certain amortization amounts that impact earnings during the period. In addition, operating cash flows are primarily affected by variations in working capital, which can be impacted by the following:
• | seasonality of NJR's business; |
• | fluctuations in wholesale natural gas prices; |
• | timing of storage injections and withdrawals; |
• | management of the deferral and recovery of gas costs; |
• | changes in contractual assets utilized to optimize margins related to natural gas transactions; and |
• | timing of the collections of receivables and payments of current liabilities. |
Net income decreased $7.1 million during during the nine months ended June 30, 2011, compared with the nine months ended June 30, 2010, due primarily to an increase of $29.9 million in unrealized losses, net of tax, associated with changes in the values of financial derivative instruments as well as realized losses, net of tax, of $36.8 million associated with natural gas in inventory at NJRES compared with realized losses, net of tax, of $16.9 million during the nine months ended June 30, 2010.
Changes in working capital, which are driven primarily by changes in volumes of natural gas purchased and sold as well as movements in commodity prices, were the major contributors to the $71.3 million increase in cash generated from operating activities. During the nine months ended June 30, 2011, the increase in cash as compared with the nine months ended June 30, 2010, resulted primarily from the following:
• | an increase in NJNG's gas costs recovered of approximately $113.9 million during the nine months ended June 30, 2011, which reflects higher volumes of gas sold during the current fiscal year, in addition to cash refunds and bill credits that NJNG issued to customers during the nine months ended June 30, 2010, that did not recur during fiscal 2011. |
• | an increase of $69 million related to lower volumes of gas in storage at NJRES and NJNG during the current fiscal year, which was offset slightly by a higher average cost; offset by |
• | an increase in margin deposits of $55.9 million due primarily to higher unrealized losses at NJRES; |
• | a decrease of $81.3 million in gas purchases payables when compared with the nine months ended June 30, 2010, due primarily to lower volumes of gas purchased at NJNG and NJRES offset slightly by an increase in the cost of gas purchases during the current fiscal year. |
NJNG's MGP expenditures are currently expected to total $19.1 million in fiscal 2011. For a more detailed description of MGP see Note 13. Commitments and Contingent Liabilities.
Page 52
New Jersey Resources Corporation
Part I
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (Continued)
Investing Activities
Cash flow used in investing activities totaled $97.9 million during the nine months ended June 30, 2011, compared with $60.7 million during the nine months ended June 30, 2010. The increase was due primarily to higher utility plant expenditures at NJNG and solar equipment expenditures at CEV, offset by a decrease in investments in Steckman Ridge.
NJNG's capital expenditures result primarily from the need for services, mains and meters to support its continued customer growth, mandated pipeline safety rulemaking and general system improvements. NJNG's capital expenditures are expected to increase in fiscal 2011 to $108.2 million when compared with the capital spending of $94.6 million in fiscal 2010. The expected expenditures for fiscal 2011 include an estimate of $26 million related to AIP I construction costs and $11 million related to AIP II. As of June 30, 2011, NJNG has incurred $24.9 million related to the AIP I program and $789,000 related to AIP II during fiscal 2011. NJNG expects capital expenditures of $116.1 million in fiscal 2012.
As of June 30, 2011, NJR had invested $126.8 million in Steckman Ridge, excluding capitalized interest and other direct costs of $7.7 million, and has received cash distributions of $16 million. Total project costs related to the development of the storage facility were previously estimated at approximately $265 million, of which NJR is obligated to fund 50 percent or approximately $132.5 million. Should there be additional construction on the facility to improve performance, NJR would have an additional funding obligation of up to $5.7 million.
Retail and Other capital expenditures in past years have been made primarily in connection with investments made to preserve the value of real estate holdings. At June 30, 2011, CR&R owned eighty-three acres of undeveloped land and a 56,400-square-foot building on five acres of land.
NJR, through NJRCEV and NJRHS, has entered into various agreements to install solar equipment involving both residential and commercial projects. During the nine months ended June 30, 2011, capital expenditures totaled $19.5 million. NJR currently estimates capital expenditures of between $70 and $80 million in fiscal 2011, of which $77.6 million has been either committed or spent. Capital expenditures in fiscal 2012 are expected to be $65.6 million.
NJRES does not currently anticipate any significant capital expenditures in fiscal 2011.
Financing Activities
Financing cash flows generally are seasonal in nature and are impacted by the volatility in pricing in the natural gas markets. NJNG's inventory levels are built up during its natural gas injection season (April through October) and reduced during withdrawal season (November through March) in response to the supply requirements of its customers. As well, changes in financing cash flows can be impacted by the funding demands of NJRES' gas management and marketing functions.
Cash flow used in financing activities totaled $(69.5) million during the nine months ended June 30, 2011, compared with $(39.8) million during the nine months ended June 30, 2010, due primarily to a decrease in proceeds from short-term borrowings at NJR and the redemption of NJNG's $20 million Series CC First Mortgage Bonds, partially offset by a decrease in treasury shares repurchased during the nine months ended June 30, 2011.
NJNG provides funding for certain of its infrastructure projects through tax exempt, variable-rate debt, which has been issued to back six series of ARS through the EDA, and are based on the borrowing costs of the ARS. During periods of reduced liquidity for ARS, NJNG's rate on its variable rate debt could default to a maximum rate of the lesser of (i) 175 percent of the thirty-day LIBOR or (ii) 10 to 12 percent, as applicable to a particular series of ARS. Although the average weighted interest rate associated with the ARS was 0.33 percent as of June 30, 2011, NJNG continues to review alternatives that would eliminate or mitigate the inherent interest rate risk associated with its variable rate debt.
NJNG received $5.9 million and $4.9 million in December 31, 2010 and 2009, respectively, in connection with the sale-leaseback of its natural gas meters. This sale-leaseback program is expected to be continued on an annual basis.
Page 53
New Jersey Resources Corporation
Part I
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (Continued)
Credit Ratings
The table below summarizes NJNG's current credit ratings issued by two rating entities, Standard and Poor's (S&P) and Moody's Investors Service, Inc. (Moody's):
Standard and Poor's | Moody's | |
Corporate Rating | A | N/A |
Commercial Paper | A-1 | P-1 |
Senior Secured | A+ | Aa3 |
Ratings Outlook | Stable | Stable |
NJNG's S&P and Moody's ratings are investment-grade ratings. NJR is not a rated entity.
NJNG is not party to any lending agreements that would accelerate the maturity date of any obligation caused by a failure to maintain any specific credit rating. If such ratings are downgraded below investment grade, borrowing costs could increase, as will the costs of maintaining certain contractual relationships and future financing. Even if ratings are downgraded without falling below investment grade, NJR and NJNG could still face increased borrowing costs under their credit facilities. A rating set forth above is not a recommendation to buy, sell or hold the Company's or NJNG's securities and may be subject to revision or withdrawal at any time. Each rating set forth above should be evaluated independently of any other rating.
The timing and mix of any external financings will target a common equity ratio that is consistent with maintaining the Company's current short-term and long-term credit ratings.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Financial Risk Management
Commodity Market Risks
Natural gas is a nationally traded commodity, and its prices are determined effectively by the NYMEX and over-the-counter markets. The prices on the NYMEX and over-the-counter markets generally reflect the national balance of natural gas supply and demand, but are also influenced significantly from time to time by other events.
The regulated and unregulated natural gas businesses of NJR and its subsidiaries are subject to market risk due to fluctuations in the price of natural gas. To economically hedge against such fluctuations, NJR and its subsidiaries have entered into forwards, futures contracts, options agreements and swap agreements. To manage these derivative instruments, NJR has well-defined risk management policies and procedures that include daily monitoring of volumetric limits and monetary guidelines. NJR's natural gas businesses are conducted through three of its operating subsidiaries. NJNG is a regulated utility that uses futures, options and swaps to economically hedge against price fluctuations, and its recovery of natural gas costs is governed by the BPU, NJRES uses futures, options, swaps and physical contracts to economically hedge purchases and sales of natural gas and NJR Energy from time to time may enter into energy-related ventures.
The following table reflects the changes in the fair market value of financial derivatives related to natural gas purchases and sales from September 30, 2010 to June 30, 2011:
Balance | Increase | Less | Balance | |||||||||||||
(Thousands) | September 30, 2010 | (Decrease) in Fair Market Value | Amounts Settled | June 30, 2011 | ||||||||||||
NJNG | $ | (16,497 | ) | $ | (7,422 | ) | $ | (16,237 | ) | $ | (7,682 | ) | ||||
NJRES | 57,538 | (12,356 | ) | 39,722 | 5,460 | |||||||||||
Total | $ | 41,041 | $ | (19,778 | ) | $ | 23,485 | $ | (2,222 | ) |
There were no changes in methods of valuations during the year ended June 30, 2011.
Page 54
New Jersey Resources Corporation
Part I
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (Continued)
The following is a summary of fair market value of financial derivatives at June 30, 2011, excluding foreign exchange contracts discussed below, by method of valuation and by maturity for each fiscal year period:
(Thousands) | 2011 | 2012 | 2013 - 2015 | After 2015 | Total Fair Value | |||||||||||||
Price based on NYMEX | $ | (8,761 | ) | $ | (3,151 | ) | $ | — | $ | — | $ | (11,912 | ) | |||||
Price based on other external data | 5,944 | 4,639 | (825 | ) | (68 | ) | 9,690 | |||||||||||
Total | $ | (2,817 | ) | $ | 1,488 | $ | (825 | ) | $ | (68 | ) | $ | (2,222 | ) |
The following is a summary of financial derivatives by type as of June 30, 2011:
Volume Bcf | Price per MMBtu | Amounts included in Derivatives (Thousands) | ||||||
NJNG | Futures | (2.5 | ) | 4.05 / 5.69 | $ | (11,274 | ) | |
Swaps | 10.7 | 4.05 / 6.15 | 3,592 | |||||
NJRES | Futures | (13.6 | ) | 4.05 / 6.72 | (637 | ) | ||
Swaps | (16.1 | ) | 3.50 / 7.19 | 6,097 | ||||
Total | $ | (2,222 | ) |
The following table reflects the changes in the fair market value of physical commodity contracts from September 30, 2010 to June 30, 2011:
Balance | Increase | Less | Balance | |||||||||||
(Thousands) | September 30, 2010 | (Decrease) in Fair Market Value | Amounts Settled | June 30, 2011 | ||||||||||
NJRES - Prices based on other external data | $ | 17,990 | 15,087 | 16,112 | $ | 16,965 |
Foreign Currency Market Risks
The following table reflects the changes in the fair market value of financial derivatives related to foreign currency hedges from September 30, 2010 to June 30, 2011:
Balance | Increase | Less | Balance | |||||||||||
(Thousands) | September 30, 2010 | (Decrease) in Fair Market Value | Amounts Settled | June 30, 2011 | ||||||||||
NJRES | $ | 25 | 255 | 91 | $ | 189 |
There were no changes in methods of valuations during the year ended June 30, 2011.
The following is a summary of fair market value of financial derivatives related to natural gas purchases and sales at June 30, 2011, by method of valuation and by maturity for each fiscal year period:
(Thousands) | 2011 | 2012 | 2013 - 2015 | After 2015 | Total Fair Value | |||||||
Prices based on other external data | $28 | 103 | 58 | — | $189 |
The Company's market price risk is predominately related to changes in the price of natural gas at Henry Hub. As the fair value of futures and our fixed swaps is derived from this location, the price sensitivity analysis below has been prepared for all open Henry Hub natural gas futures and fixed swap positions. Based on this, an illustrative 10 percent movement in Henry Hub natural gas futures contract prices for example, increases (decreases) the reported derivative fair value of all open Henry Hub natural gas futures and fixed swap positions by approximately $12.4 million. This analysis does not include potential changes to reported credit adjustments embedded in the $(1.8) million reported fair value.
Page 55
New Jersey Resources Corporation
Part I
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (Continued)
Derivative Fair Value Sensitivity Analysis | |||||||||||||||
(Thousands) | HENRY HUB FUTURES and FIXED PRICE SWAPS | ||||||||||||||
% increase in NYMEX natural gas futures prices | — | % | 5 | % | 10 | % | 15 | % | 20 | % | |||||
Estimated change in derivative fair value | $ | — | $ | (6,183 | ) | $ | (12,366 | ) | $ | (18,549 | ) | $ | (24,732 | ) | |
Ending derivative fair value | $ | (1,796 | ) | $ | (7,979 | ) | $ | (14,162 | ) | $ | (20,345 | ) | $ | (26,528 | ) |
% decrease in NYMEX natural gas futures prices | — | % | (5 | )% | (10 | )% | (15 | )% | (20 | )% | |||||
Estimated change in derivative fair value | $ | — | $ | 6,183 | $ | 12,366 | $ | 18,549 | $ | 24,732 | |||||
Ending derivative fair value | $ | (1,796 | ) | $ | 4,387 | $ | 10,570 | $ | 16,753 | $ | 22,936 |
Wholesale Credit Risk
NJNG, NJRES and NJR Energy engage in wholesale marketing activities. NJR monitors and manages the credit risk of its wholesale marketing operations through credit policies and procedures that management believes reduce overall credit risk. These policies include a review and evaluation of prospective counterparties' financial statements and/or credit ratings, daily monitoring of counterparties' credit limits, daily communication with traders regarding credit status and the use of credit mitigation measures, such as minimum margin requirements, collateral requirements and netting agreements. Examples of collateral include letters of credit and cash received for either prepayment or margin deposit.
The Company's RMC continuously monitors NJR's credit risk management policies and procedures. The RMC is comprised of individuals from NJR-affiliated companies that meet twice a month and, among other things, evaluates the effectiveness of existing credit policies and procedures, reviews material transactions and discusses emerging issues.
The following is a summary of gross and net credit exposures, grouped by investment and noninvestment grade counterparties, as of June 30, 2011. Gross credit exposure is defined as the unrealized fair value of derivative and energy trading contracts plus any wholesale outstanding receivable for the value of natural gas delivered for which payment has not yet been received. Net credit exposure is defined as gross credit exposure reduced by collateral received from counterparties and/or payables, where netting agreements exist. The amounts presented below exclude accounts receivable for NJNG retail natural gas sales and services.
NJRES' counterparty credit exposure as of June 30, 2011, is as follows:
(Thousands) | Gross Credit Exposure | Net Credit Exposure | ||||||
Investment grade | $ | 151,296 | $ | 101,779 | ||||
Noninvestment grade | 10,452 | 3,518 | ||||||
Internally rated investment grade | 46,668 | 18,086 | ||||||
Internally rated noninvestment grade | 11,188 | 2,337 | ||||||
Total | $ | 219,604 | $ | 125,720 |
NJNG's counterparty credit exposure as of June 30, 2011, is as follows:
(Thousands) | Gross Credit Exposure | Net Credit Exposure | ||||||
Investment grade | $ | 13,302 | $ | 10,703 | ||||
Noninvestment grade | 115 | — | ||||||
Internally rated investment grade | 1,104 | 504 | ||||||
Internally rated noninvestment grade | 139 | 2 | ||||||
Total | $ | 14,660 | $ | 11,209 |
Due to the inherent volatility in the prices of natural gas commodities and derivatives, the market value of contractual positions with individual counterparties could exceed established credit limits or collateral provided by those counterparties. If a counterparty failed to perform the obligations under its contract (for example, failed to deliver or pay for natural gas), then the Company could sustain a loss. This loss would comprise the loss on natural gas delivered but not paid for and/or the cost of replacing natural gas not delivered at a price higher than the price in the original contract. Any such loss could have a material impact on the Company's financial condition, results of operations or cash flows.
Page 56
New Jersey Resources Corporation
Part I
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (Continued)
Interest Rate Risk
As of June 30, 2011, NJNG is obligated with respect to loan agreements securing six series of auction-rate bonds totaling $97 million of variable-rate debt backed by securities issued by the EDA. The EDA bonds are ARS and have an interest rate reset every seven or thirty-five days, depending upon the applicable series, when an auction is held for the purposes of determining the interest rate pricing of the securities. The interest rate associated with the NJNG variable-rate debt is based on the rates the EDA receives from its ARS. As of June 30, 2011, all of the auctions surrounding the EDA ARS have failed, resulting in the securities bearing interest at their maximum rates, as defined in the ARS, as the lesser of (i) 175 percent of thirty-day LIBOR or (ii) 10 to 12 percent per annum, as applicable to such series of ARS. While the failure of the ARS auctions has no default impact on NJNG's variable-rate debt, it does impact its borrowing costs of the variable-rate debt. At June 30, 2011, the thirty-day LIBOR rate was 0.19 percent. As such, NJNG currently has a weighted average interest rate of 0.33 percent as of June 30, 2011. There can be no assurance that the EDA ARS will have enough market liquidity to avoid failed auctions in the future, which could potentially have an adverse impact on NJNG's borrowing costs if LIBOR rates increase. LIBOR rates are set by market forces and as a result subject to unforeseen changes. A 100 basis point change in the thirty-day LIBOR average interest rate would have caused a change in interest expense for these variable rate bonds by approximately $1.3 million during the nine months ended June 30, 2011. NJNG is currently planning a refinancing of the EDA ARS, replacing them with variable rate demand bonds to be issued by the EDA which, subject to closing and market conditions, is expected to be completed by the end of fiscal 2011. NJNG cannot assure that the alternative sources of financing can be implemented in a timely manner to completely mitigate sudden increases in NJNG's borrowing costs.
At June 30, 2011, the Company (excluding NJNG) had no variable-rate long-term debt.
For more information regarding the interest rate risk related to our short-term debt, please see Item 2. Liquidity and Capital Resources - Debt.
Effects of Inflation
Although inflation rates have been relatively low to moderate in recent years, any change in price levels has an effect on operating results due to the capital-intensive and regulated nature of the Company's utility subsidiary. The Company attempts to minimize the effects of inflation through cost control, productivity improvements and regulatory actions where appropriate.
ITEM 4. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
Under the supervision and with the participation of the Company's management, including the principal executive officer and principal financial officer, the Company conducted an evaluation of the effectiveness of the design and operation of its disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) (the Exchange Act), as of the end of the period covered by this report. Based on this evaluation, the Company's principal executive officer and principal financial officer concluded that, as of end of the period covered by this report, the Company's disclosure controls and procedures are effective, to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act, is recorded, processed, summarized and reported, within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to the Company's management, including its principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.
Changes in Internal Control over Financial Reporting
There has been no change in internal control over financial reporting (as such term is defined in Exchange Act Rule 13a-15(f)) that occurred during the quarter ended June 30, 2011, that has materially affected, or is reasonably likely to materially affect, internal control over financial reporting.
Page 57
New Jersey Resources Corporation
Part II
ITEM 1. LEGAL PROCEEDINGS
Information regarding reportable legal proceedings is contained in Part I, "Item 3. Legal Proceedings" in NJR's Annual Report on Form 10-K for the year ended September 30, 2010, and is set forth in Part I, Item 1, Note 13. Commitment and Contingent Liabilities-Legal Proceedings in the Unaudited Condensed Consolidated Financial Statements. No legal proceedings became reportable during the quarter ended June 30, 2011, and there have been no material developments during such quarter regarding any previously reported legal proceedings, which have not been previously disclosed.
ITEM 1A. RISK FACTORS
While NJR attempts to identify, manage and mitigate risks and uncertainties associated with its business to the extent practical, under the circumstances, some level of risk and uncertainty will always be present. Part I, Item 1A, "Risk Factors," of NJR's 2010 Annual Report on Form 10-K includes a detailed discussion of NJR's risk factors. Those risks and uncertainties have the potential to materially affect NJR's financial condition and results of operations. NJR does not believe that there have been any material changes from the risk factors as previously disclosed by NJR in the 2010 Annual Report on Form 10-K, except that the following is an additional risk factor that should be read to supplement to the previously disclosed risk factors:
A change in our effective tax rate as a result of a failure to qualify for ITCs or being delayed in qualifying for ITCs due to delays or failures to complete planned solar energy projects may have a material impact on our net financial earnings.
Generally accepted accounting principles require NJR to apply an effective tax rate to interim periods that is consistent with our estimated annual effective tax rate. As a result, quarterly, NJR projects the annual effective tax rate and then adjusts the tax expense recorded in that quarter to reflect the projected annual effective tax rate. The amount of the quarterly adjustment is based on information and assumptions, which are subject to change and which may have a material impact on quarterly and annual net financial earnings. Factors we consider in estimating the probability of projects being completed during the fiscal year include, but are not limited to, board of directors approval, execution of various contracts, including power purchase agreements, construction logistics, permitting and interconnection completion. If NJR fails to qualify for ITCs or is delayed in qualifying for some ITCs during the fiscal year due to delays or failures to complete planned solar energy projects as scheduled our quarterly and annual net financial earnings may be materially impacted.
ITEM 2. UNREGISTERED SALE OF EQUITY SECURITIES AND USE OF PROCEEDS
The following table sets forth NJR's repurchase activity for the quarter ended June 30, 2011:
Period | Total Number of Shares (or Units) Purchased | Average Price Paid per Share (or Unit) | Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs | Maximum Number (or Approximate Dollar Value) of Shares (or Units) That May Yet Be Purchased Under the Plans or Programs | ||||
04/01/11 - 04/30/11 | — | — | — | 1,511,970 | ||||
05/01/11 - 05/31/11 | — | — | — | 1,511,970 | ||||
06/01/11 - 06/30/11 | — | — | — | 1,511,970 | ||||
Total | — | — | — | 1,511,970 |
ITEM 4. (REMOVED AND RESERVED)
Page 58
New Jersey Resources Corporation
Part II
ITEM 6. EXHIBITS
4.4a | Amendment dated March 18, 2011, to Credit Agreement dated as of December 13, 2007, by and among New Jersey Resources Corporation, the guarantors thereto, PNC Bank, NA as Administrative Agent, the banks party thereto.+ |
31.1 | Certification of the Chief Executive Officer pursuant to section 302 of the Sarbanes-Oxley Act |
31.2 | Certification of the Chief Financial Officer pursuant to section 302 of the Sarbanes-Oxley Act |
32.1 | Certification of the Chief Executive Officer pursuant to section 906 of the Sarbanes-Oxley Act* |
32.2 | Certification of the Chief Financial Officer pursuant to section 906 of the Sarbanes-Oxley Act* |
101 | Interactive Data File (Form 10-Q, for the fiscal period ended June 30, 2011, furnished in XBRL (eXtensible Business Reporting Language)). |
+ Filed herewith.
* This certificate accompanies this report pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not be deemed filed by NJR for purposes of Section 18 or any other provision of the Securities Exchange Act of 1934, as amended.
Page 59
New Jersey Resources Corporation
Part II
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
NEW JERSEY RESOURCES CORPORATION | ||
(Registrant) | ||
Date: | August 4, 2011 | |
By:/s/ Glenn C. Lockwood | ||
Glenn C. Lockwood | ||
Executive Vice President and | ||
Chief Financial Officer |
Page 60