Item 1. Business
Units of Measurement
For Natural Gas:
1 dt
= One decatherm
1 MMdt
= One million decatherms
Dts/d
= Decatherms per day
MDWQ
= Maximum daily withdrawal quantity
Description of Business
South Jersey Gas Company (SJG) is a regulated natural gas utility. SJG distributes natural gas in the seven southernmost counties of New Jersey.
Additional information on the nature of our business is incorporated by reference to “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Market Risk” and Note 3, “Rates and Regulatory Actions.”
Financial Information About Reportable Segments
Not applicable.
Rates and Regulation
Information on our rates and regulatory affairs is incorporated by reference to “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Note 3, “Rates and Regulatory Actions.”
Sources and Availability of Raw Materials
Transportation and Storage Agreements
SJG has direct connections to the interstate pipeline systems of both Transcontinental Gas Pipe Line Company, LLC (Transco) and Columbia Gas Transmission, LLC (Columbia). During 2011, SJG purchased and had delivered approximately 37.7 million decatherms (MMdts) of natural gas for distribution to both on-system and off-system customers. Of this total, 22.7 MMdts were transported on the Transco pipeline system while 15.0 MMdts were transported on the Columbia pipeline system. Moreover, during 2011 third-party suppliers delivered 30.3 MMdts to SJG's system on behalf of end use customers behind our city gate stations. SJG also secures firm transportation and other long term services from one additional pipeline upstream of the Transco and Columbia systems. This upstream pipeline is owned by Dominion Transmission, Inc. (Dominion). Services provided by Dominion are utilized to deliver gas into either the Transco or Columbia systems for ultimate delivery to SJG. Services provided by all of the above-mentioned pipelines are subject to the jurisdiction of the Federal Energy Regulatory Commission (FERC). Unless otherwise indicated, our intentions are to renew or extend these service agreements before they expire.
Transco:
Transco is SJG’s largest supplier of long-term gas transmission services which includes both year-round and seasonal firm transportation (FT) service arrangements. When combined, these FT services enable SJG to purchase gas from third parties and have delivered to its city gate stations by Transco a total of 280,525 dts per day (dts/d). Of this total, 133,917 dts/d is long-haul FT (where gas can be transported from the production areas of the Southwest to the market areas of the Northeast) while 146,608 dts/d is market area FT. The terms of SJG’s year-round agreements extend for various periods through 2025. The terms of its seasonal agreements vary in length with the longest extending into 2012.
Of the 280,525 dts/d of Transco services mentioned above, SJG has released a total of 39,800 dts/d of its long-haul FT and 25,565 dts/d of its market area FT service. These releases were made in association with SJG’s Conservation Incentive Program (CIP) discussed further under Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations. In addition, SJG released 90,000 dts/d of market area FT SJRG as part of an Asset Management Agreement, discussed further in this section under “Gas Supplies.”
SJG currently has six (6) long-term gas storage service agreements with Transco that, when combined, are capable of storing approximately 5.0 MMdts. Through these agreements, SJG can inject gas into market and production area storages during periods of low demand and extract gas at a Maximum Daily Withdrawal Quantity (MDWQ) of up to 107,407 dts during periods of high demand. The longest term of these storage service agreements extends through 2013.
Dominion:
SJG subscribes to a firm storage service from Dominion, under its Rate Schedule GSS. This storage has a MDWQ of 10,000 dts during the period between November 16 and March 31 of each winter season, with an associated total storage capacity of 423,000 dts. Gas withdrawn from Dominion GSS storage is delivered through both the Dominion and Transco (Leidy Line) pipeline systems for delivery to SJG service territory. The primary term of this agreement extends through March 31, 2015.
Columbia:
Entering 2011, SJG had two firm transportation agreements with Columbia which, at the time, provided for 45,022 dts/d of firm deliverability with each extending through October 31, 2019. In 2011, SJG secured a third firm transportation agreement with Columbia for an incremental 9,000 dts/d of capacity the primary term of which extends through October 2012. When combined, these three agreements provide SJG with a total of 54,022 dts/d of firm transportation rights on Columbia. SJG had previously released 14,714 dts/d of this amount to SJRG in conjunction with its CIP thereby reducing the combined availability of firm transportation on the Columbia system to 30,308 dts/d.
SJG also subscribes to a firm storage service with Columbia under its Rate Schedule FSS along with an associated firm transportation service under Rate Schedule SST each of which extends through October 31, 2019. The Company has a total FSS MDWQ of 52,891 dts and with a related 3,473,022 dts of storage capacity. SJG released to SJRG 19,029 dts of its FSS MDWQ along with 1,249,485 dts of its FSS storage capacity. Additionally, SJG also released to SJRG 19,029 dts/d of its Columbia SST transportation service. Both releases made by SJG were in connection with its CIP and extend through September 30, 2014.
Gas Supplies
SJG has an Asset Management Agreement (AMA) with SJRG that extends through November 30, 2013. Under this agreement SJG has released to SJRG its firm transportation rights equal to 90,000 dts/d of transportation capacity on Transco. SJRG will manage this capacity and provide SJG with up to 90,000 dts/d of firm deliverability in the summer season and up to 90,000 dts/d of interruptible deliverability in the winter season. SJRG will seek to optimize the capacity released under this AMA and will pay SJG a fee based on a sharing formula in the agreement.
In 2011, SJG entered into a long-term gas purchase agreement with Antero Resources Appalachian Corporation (Antero) the primary term of which extends through October 31, 2019. The maximum daily quantities (MDQ) available for purchase under this agreement initially starts at 6,250 dts/d and ratchets up to a MDQ of 25,000 dts/d. Gas purchased from Antero will be sourced in the Appalachian supply areas and delivered into the Columbia pipeline system for delivery to SJG.
Due to increased liquidity in the market place, all other gas supply agreements with third party suppliers are short-term agreements and SJG uses financial contracts secured through SJRG to hedge against forward price risk. Short-term agreements typically extend between one day and several months in duration.
Supplemental Gas Supplies
During 2011, SJG entered into two seasonal Liquefied Natural Gas (LNG) sales agreements with a third party supplier. The term of the first agreement, which was used during the 2011 summer season to refill SJG’s storage tank, extended through October 31, 2011, and had an associated contract quantity of 210,000 dts. The second agreement was acquired to replenish LNG in storage during the 2011-2012 winter season. This agreement extends through March 31, 2012 and provides SJG with up to 310,000 dts of LNG.
SJG operates peaking facilities which can store and vaporize LNG for injection into its distribution system. SJG’s LNG facility has a storage capacity equivalent to 434,300 dts of natural gas and has an installed capacity to vaporize up to 118,250 dts of LNG per day for injection into its distribution system.
Peak-Day Supply
SJG plans for a winter season peak-day demand on the basis of an average daily temperature of 2 degrees Fahrenheit (F). Gas demand on such a design day for the 2011-2012 winter season is estimated to be 458,180 dts. SJG projects that it has adequate supplies and interstate pipeline entitlements to meet its design requirements. SJG experienced its highest peak-day demand for calendar year 2011 of 414,100 dts on January 23rd while experiencing an average temperature of 18.2 degrees F that day.
Natural Gas Prices
SJG’s average cost of natural gas purchased and delivered in 2011, 2010 and 2009, including demand charges, was $6.11 per dt, $6.64 per dt and $8.38 per dt, respectively.
Patents and Franchises
SJG holds nonexclusive franchises granted by municipalities in the seven-county area of southern New Jersey that it serves. No other natural gas public utility presently serves the territory covered by SJG’s franchises. Otherwise, patents, trademarks, licenses, franchises and concessions are not material to the business of SJG.
Seasonal Aspects
SJG experiences seasonal fluctuations in sales when selling natural gas for heating purposes. SJG meets this seasonal fluctuation in demand from its firm customers by buying and storing gas during the summer months, and by drawing from storage and purchasing supplemental supplies during the heating season. As a result of this seasonality, SJG’s revenues and net income are significantly higher during the first and fourth quarters than during the second and third quarters of the year.
Working Capital Practices
Reference is made to “Liquidity and Capital Resources” included in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, of this report.
Customers
No material part of SJG’s business is dependent upon a single customer or a few customers, the loss of which would have a material adverse effect on SJG’s business. See Item 1, “Description of Business.”
Backlog
Backlog is not material to an understanding of SJG’s business.
Government Contracts
No material portion of SJG’s business is subject to renegotiation of profits or termination of contracts or subcontracts at the election of any government.
Competition
Information on competition is incorporated by reference to “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, of this report.
Research
During the last three fiscal years, SJG did not engage in research activities to any material extent.
Environmental Matters
Information on environmental matters can be found in Note 12 of the financial statements included under Item 8 of this report.
Employees
SJG had a total of 443 employees as of December 31, 2011. Of that total, 279 employees are unionized. There are 37 unionized employees represented by the International Brotherhood of Electrical Workers (IBEW) that operate under a collective bargaining agreement that runs through February 2013, with the option to extend until February 2014 at the union's election. The remaining unionized employees are represented by the International Association of Machinists and Aerospace Workers (IAM). Employees represented by the IAM operate under a collective bargaining agreement that expires in August 2014.
SJG has no foreign operations and export sales are not a part of its business.
Item 1A.
Item 1A. Risk Factors
SJG operates in an environment that involves risks, many of which are beyond our control. The Company has identified the following risk factors that could cause the Company’s operating results and financial condition to be materially adversely affected. Security Holders should carefully consider these risk factors and should also be aware that this list is not all-inclusive of existing risks. In addition, new risks may emerge at any time, and the Company cannot predict those risks or the extent to which they may affect the Company’s businesses or financial performance.
•
SJG’s business activities are concentrated in southern New Jersey. Changes in the economies of southern New Jersey and surrounding regions could negatively impact the growth opportunities available to SJG and the financial condition of customers and prospects of SJG.
•
Changes in the regulatory environment or unfavorable rate regulation may have an unfavorable impact on SJG’s financial performance or condition. SJG’s business is regulated by the New Jersey Board of Public Utilities which has authority over many of the activities of the business including, but not limited to, the rates it charges to its customers, the amount and type of securities it can issue, the nature of investments it can make, the nature and quality of services it provides, safety standards and other matters. The extent to which the actions of regulatory commissions restrict or delay SJG’s ability to earn a reasonable rate of return on invested capital and/or fully recover operating costs may adversely affect its results of operations, financial condition and cash flows.
•
SJG may not be able to respond effectively to competition, which may negatively impact SJG’s financial performance or condition. Regulatory initiatives may provide or enhance opportunities for competitors that could reduce utility income obtained from existing or prospective customers. Also, competitors may be able to provide superior or less costly products or services based upon currently available or newly developed technologies.
•
Warm weather, high commodity costs, or customer conservation initiatives could result in reduced demand for natural gas. While SJG currently has a conservation incentive program clause that protects its revenues and gross margin against usage that is lower than a set level, the clause is currently approved as a pilot program through 2013. Should this clause expire without replacement, lower customer energy utilization levels would likely reduce SJG’s net income.
•
High natural gas prices could cause more of SJG’s receivables to be uncollectible. Higher levels of uncollectibles from utility customers would negatively impact SJG’s income and could result in higher working capital requirements.
•
SJG’s net income could decrease if it is required to incur additional costs to comply with new governmental safety, health or environmental legislation. SJG is subject to extensive and changing federal and state laws and regulations that impact many aspects of its business; including the storage, transportation and distribution of natural gas, as well as the remediation of environmental contamination at former manufactured gas plant facilities.
•
Increasing interest rates would negatively impact the net income of SJG. SJG is capital intensive, resulting in the incurrence of significant amounts of debt financing. SJG has issued all long-term debt either at fixed rates or has utilized interest rate swaps to mitigate changes in floating rates. However, new issues of long-term debt and all variable rate short-term debt are exposed to the impact of rising interest rates.
•
The inability to obtain capital, particularly short-term capital from commercial banks, could negatively impact the daily operations and financial performance of SJG. SJG uses short-term borrowings under both a commercial paper program and committed and uncommitted credit facilities provided by commercial banks to supplement cash provided by operations, to support working capital needs, and to finance capital expenditures, as incurred. If the customary sources of short-term capital were no longer available due to market conditions, SJG may not be able to meet its working capital and capital expenditure requirements and borrowing costs could increase.
•
A downgrade in SJG’s credit ratings could negatively affect its ability to access adequate and cost effective capital. SJG’s ability to obtain adequate and cost effective capital depends largely on its credit ratings, which are greatly influenced by financial condition and results of operations. If the rating agencies downgrade SJG’s credit ratings, particularly below investment grade, SJG’s borrowing costs would increase. In addition, SJG would likely be required to pay higher interest rates in future financings and potential funding sources would likely decrease.
•
The inability to obtain natural gas would negatively impact the financial performance of SJG. SJG’s business is based upon the ability to deliver natural gas to customers. Disruption in the production of natural gas or transportation of that gas to SJG from its suppliers could prevent SJG from completing sales to its customers.
•
Transporting and storing natural gas involves numerous risks that may result in accidents and other operating risks and costs. SJG’s gas distribution activities involve a variety of inherent hazards and operating risks, such as leaks, accidents and mechanical problems, which could cause substantial financial losses. In addition, these risks could result in loss of human life, significant damage to property, environmental pollution and impairment of operations, which in turn could lead to substantial losses. In accordance with customary industry practice, SJG maintains insurance against some, but not all, of these risks and losses. The occurrence of any of these events not fully covered by insurance could adversely affect SJG’s financial position, results of operations and cash flow.
•
Adverse results in legal proceedings could be detrimental to the financial condition of SJG. The outcomes of legal proceedings can be unpredictable and can result in adverse judgments.
•
Climate change legislation could impact SJG’s financial performance and condition. Climate change is receiving ever increasing attention from scientists and legislators alike. The debate is ongoing as to the extent to which our climate is changing, the potential causes of this change and its future impacts. Some attribute global warming to increased levels of greenhouse gases, which has led to significant legislative and regulatory efforts to limit greenhouse gas emissions. The outcome of federal and state actions to address global climate change could result in a variety of regulatory programs including additional charges to fund energy efficiency activities or other regulatory actions. These actions could affect the demand for natural gas and electricity, result in increased costs to our business and impact the prices we charge our customers. Because natural gas is a fossil fuel with low carbon content, it is possible that future carbon constraints could create additional demands for natural gas, both for production of electricity and direct use in homes and businesses. Any adoption by federal or state governments mandating a substantial reduction in greenhouse gas emissions could have far-reaching and significant impacts on the energy industry. We cannot predict the potential impact of such laws or regulations on our future financial condition, results of operations or cash flows.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
The principal property of SJG consists of its gas transmission and distribution systems that include mains, service connections and meters. The transmission facilities carry the gas from the connections with Transco and Columbia to SJG’s distribution systems for delivery to customers. As of December 31, 2011, there were approximately 124.1 miles of mains in the transmission systems and 6,020 miles of mains in the distribution systems.
SJG owns 154 acres of land in Folsom, New Jersey, which is the site of its corporate headquarters. Approximately 140 acres of this property are deed restricted. SJG also has office and service buildings at six other locations in the territory. There is a liquefied natural gas storage and vaporization facility at one of these locations.
As of December 31, 2011, SJG’s utility plant had a gross book value of $1.5 billion and a net book value, after accumulated depreciation, of $1.2 billion. In 2011, $142.6 million was spent on additions to utility plant and there were retirements of property having an aggregate gross book cost of $12.4 million.
Virtually all of SJG’s transmission pipeline, distribution mains and service connections are under streets or highways or on the property of others. The transmission and distribution systems are maintained under franchises or permits or rights-of-way, many of which are perpetual. SJG’s properties (other than property specifically excluded) are subject to a lien of mortgage under which its first mortgage bonds are outstanding. We believe these properties are well maintained and in good operating condition.
Item 3.
Item 3. Legal Proceedings
SJG is subject to claims which arise in the ordinary course of business and other legal proceedings. We accrue liabilities related to these claims when we can reasonably estimate the amount or range of amounts of probable settlement costs or other charges for these claims. The Company has accrued approximately $0.2 million and $1.4 million related to all claims in the aggregate, as of December 31, 2011 and 2010, respectively. Management does not believe that it is reasonably possible that there would be a material change in the Company's estimated liability in the near term and does not currently anticipate the disposition of any known claims to have a material effect on our financial position, results of operations or liquidity.
Item 4.
Item 4. Mine Safety Disclosures
Not Applicable
Part II
Item 5.
Item 5. Market for the Registrant’s Common Equity
Related Stockholder Matters, and Issuer Purchases of Equity Securities
Common equity securities of SJG, owned by its parent company, South Jersey Industries, Inc., are not traded on any stock exchange. SJG no longer has any preferred stock outstanding.
SJG is restricted under its First Mortgage Indenture, as supplemented, as to the amount of cash dividends or other distributions that may be paid on its common stock. As of December 31, 2011, these restrictions did not affect the amount that may be distributed from SJG’s retained earnings. Dividends of $12.7 million were declared and paid on SJG’s common stock in 2011 and $45.9 million were declared and paid in 2010.
Item 6.
Item 6. Selected Financial Data
The following financial data has been obtained from SJG’s audited financial statements (In thousands, except for Ratio Data and Customers):
(1) The ratio of earnings to fixed charges represents, on a pre-tax basis, the number of times earnings cover fixed charges. Earnings consist of net income, to which has been added fixed charges and taxes based on income of the company. Fixed charges consist of interest charges.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition
and Results of Operations
OVERVIEW:
Organization - We are an operating public utility company engaged in the purchase, transmission and sale of natural gas for residential, commercial and industrial use. We also sell natural gas and pipeline transportation capacity (off-system sales) on a wholesale basis to various customers on the interstate pipeline system and transport natural gas purchased directly from producers or suppliers to their customers.
Our service territory covers approximately 2,500 square miles in the southern part of New Jersey. It includes 112 municipalities throughout Atlantic, Cape May, Cumberland and Salem Counties and portions of Burlington, Camden and Gloucester Counties, with an estimated permanent population of 1.2 million. We benefit from our proximity to Philadelphia, PA and Wilmington, DE on the western side of our service territory and Atlantic City, NJ and the popular shore communities on the eastern side. Continuing expansion of our infrastructure throughout our 7-county region has fueled annual customer growth and creates opportunities for future extension into areas not yet served by natural gas. In the past, economic growth in Atlantic City and the surrounding region has been primarily driven by new and proposed gaming and non-gaming investments that emphasize destination style attractions. While many of these new projects were suspended or postponed due to the current economic environment, construction activity has resumed in Atlantic City, most notably on a new entertainment resort expected to open in April 2012. Combining with the gaming industry catalyst is the ongoing transition of southern New Jersey’s oceanfront communities from seasonal resorts to year round economies. Building expansions in the medical, hospitality and education sectors throughout the service territory have contributed to our growth. Presently, we serve approximately 67% of households within our territory with natural gas. We also serve southern New Jersey’s diversified industrial base that includes processors of petroleum and agricultural products; chemical, glass and consumer goods manufacturers; and high technology parks.
As of December 31, 2011, we served 351,304 residential, commercial and industrial customers in southern New Jersey, compared with 347,725 customers at December 31, 2010. No material part of our business is dependent upon a single customer or a few customers. Gas sales, transportation and capacity release for 2011 amounted to 128.1 MMdts (million dekatherms), of which 54.9 MMdts were firm sales and transportation, 1.8 MMdts were interruptible sales and transportation and 71.4 MMdts were off-system sales and capacity release. The breakdown of firm sales and transportation includes 41.3% residential, 20.3% commercial, 24.3% industrial, and 14.1% cogeneration and electric generation. At year-end 2011, we served 327,678 residential customers, 23,169 commercial customers and 457 industrial customers. This includes 2011 net additions of 3,432 residential customers and 159 commercial customers.
We make wholesale gas sales to gas marketers for resale and ultimate delivery to end users. These “off-system” sales are made possible through the issuance of the Federal Energy Regulatory Commission (FERC) Orders No. 547 and 636. Order No. 547 issued a blanket certificate of public convenience and necessity authorizing all parties, which are not interstate pipelines, to make FERC jurisdictional gas sales for resale at negotiated rates, while Order No. 636 allowed us to deliver gas at delivery points on the interstate pipeline system other than our own city gate stations and release excess pipeline capacity to third parties. During 2011, off-system sales amounted to 8.0 MMdts and capacity release amounted to 63.4 MMdts.
Supplies of natural gas available to us that are in excess of the quantity required by those customers who use gas as their sole source of fuel (firm customers) make possible the sale and transportation of gas on an interruptible basis to commercial and industrial customers whose equipment is capable of using natural gas or other fuels, such as fuel oil and propane. The term “interruptible” is used in the sense that deliveries of natural gas may be terminated by us at any time if this action is necessary to meet the needs of higher priority customers as described in our tariffs. In 2011 usage by interruptible customers, excluding off-system customers, amounted to 1.8 MMdts, approximately 1.4% of the total throughput.
Our primary goals are to: 1) provide safe, reliable natural gas service at the lowest cost possible; 2) promote natural gas as the fuel of choice for residential, commercial and industrial customers; and 3) aid our customers in becoming more energy efficient.
The following is a summary of the primary factors we expect to have the greatest impact on our performance and our ability to achieve our goals going forward:
Business Model - We are the primary focus of our parent, SJI, and will continue to account for the majority of SJI’s net income by maximizing the growth potential of our service territory.
Customer Growth - Southern New Jersey, our primary area of operations, has not been immune to the issues impacting the new housing market nationally. However, net customers for SJG still grew 1.0% as we increased our focus on customer conversions. In 2011, the 3,928 consumers converting their homes and businesses from other heating fuels, such as electric, propane or oil represented over 65% of the total new customer acquisitions for the year. In comparison, conversions over the past five years averaged 3,071 annually. Customers in our service territory typically base their decisions to convert on comparisons of fuel costs, environmental considerations and efficiencies. As such, SJG began a comprehensive partnership with the State’s Office of Clean Energy to educate consumers on energy efficiency and to promote the rebates and incentives available to natural gas users.
Regulatory Environment - We are primarily regulated by the New Jersey Board of Public Utilities (BPU). The BPU sets the rates that we charge our rate-regulated customers for services provided and establishes the terms of service under which we operate. We expect the BPU to continue to set rates and establish terms of service that will enable us to obtain a fair and reasonable return on capital invested. The BPU approved a Conservation Incentive Program (CIP) effective October 1, 2006, discussed in greater detail under “Results of Operations,” that protects our net income from reductions in gas used by our residential, commercial, and small industrial customers. In addition, in March 2011, the BPU approved an extension of the Capital Investment Recovery Tracker (CIRT II) allowing SJG to accelerate $60.3 million of capital spending into 2011 and 2012. Under CIRT II, the Company capitalizes a return on CIRT II investments until they are recovered in rate base as utility plant in service.
Weather Conditions and Customer Usage Patterns - Usage patterns can be affected by a number of factors, such as wind, precipitation, temperature extremes and customer conservation. Our earnings are largely protected from fluctuations in temperatures by the CIP. The CIP has a stabilizing effect on earnings as we adjust revenues when actual usage per customer experienced during an annual period varies from an established baseline usage per customer.
Changes in Natural Gas Prices - Gas costs are passed on directly to customers without any profit margin added. For the vast majority of our customers, the price for natural gas is set annually, with a regulatory mechanism in place to make limited adjustments to that price during the course of a year. In the event that gas cost increases would justify customer price increases greater than those permitted under the regulatory mechanism, we can petition the BPU for an incremental rate increase. High prices can make it more difficult for our customers to pay their bills and may result in elevated levels of bad-debt expense.
Changes in Interest Rates - We have operated in a relatively low interest rate environment over the past several years. Rising interest rates would raise the expense associated with all issuances of new debt. We have sought to mitigate the impact of a potential rising rate environment by directly issuing fixed-rate debt, or by entering into derivative transactions to hedge against rising interest rates.
Labor and Benefit Costs - Labor and benefit costs have a significant impact on our profitability. Benefit costs, especially those related to pension and health care, have risen in recent years. We sought to manage these costs by revising health care plans offered to existing employees, capping postretirement health care benefits, and changing health care and pension packages offered to new hires. We expect savings from these changes to gradually increase as new hires replace retiring employees. In an effort to accelerate the realization of those benefits, we had offered a voluntary separation program at the beginning of 2010 to our unionized employees. Our workforce totaled 443 employees at the end of 2011, with 279 of that total unionized.
Balance Sheet Strength - Our goal is to maintain a strong balance sheet with an average annual equity-to-capitalization ratio of 46% to 50%. Our equity-to-capitalization ratio, inclusive of short-term debt, was 49% at the end of both 2011 and 2010. A strong balance sheet permits us the financial flexibility necessary to address volatile economic and commodity markets while maintaining a low-risk platform.
Critical Accounting Policies - Estimates and Assumptions - As described in the notes to our financial statements, management must make estimates and assumptions that affect the amounts reported in the financial statements and related disclosures. Actual results could differ from those estimates. Five types of transactions presented in our financial statements require a significant amount of judgment and estimation. These relate to regulatory accounting, derivatives, environmental remediation costs, pension and other postretirement benefit costs, and revenue recognition.
Regulatory Accounting- We maintain our accounts according to the Uniform System of Accounts as prescribed by the New Jersey Board of Public Utilities (BPU). As a result of the ratemaking process, we are required to follow Financial Accounting Standards Board (FASB) ASC Topic 980 - “Regulated Operations.” We are required under Topic 980 to recognize the impact of regulatory decisions on our financial statements. We are required under our Basic Gas Supply Service (BGSS) clause to forecast our natural gas costs and customer consumption in setting our rates. Subject to BPU approval, we are able to recover or return the difference between gas cost recoveries and the actual costs of gas through a BGSS charge to customers. We record any over/under recoveries as a regulatory asset or liability on the balance sheets and reflect it in the BGSS charge to customers in subsequent years. We also enter into derivatives that are used to hedge natural gas purchases. The offset of the resulting derivative assets or liabilities is also recorded as a regulatory asset or liability on the balance sheets. See additional detailed discussions on Rates and Regulatory Actions in Note 3 to the financial statements.
Derivatives - We recognize assets or liabilities for contracts that qualify as derivatives when contracts are executed. We record contracts at their fair value in accordance with FASB ASC Topic 815 - “Derivatives and Hedging.” We record changes in the fair value of the effective portion of derivatives qualifying as cash flow hedges, net of tax, in Accumulated Other Comprehensive Loss and recognize such changes in the income statement when the hedged item affects earnings. Changes in the fair value of derivatives not designated as hedges are recorded in earnings in the current period. Currently, we do not designate energy-related derivative instruments as cash flow hedges. Certain derivatives that result in the physical delivery of the commodity may meet the criteria to be accounted for as normal purchases and normal sales, if so designated, in which case the contract is not marked-to-market, but rather is accounted for when the commodity is delivered. Due to the application of regulatory accounting principles under GAAP, derivatives related to gas purchases that are marked-to-market are recorded through our BGSS. We periodically enter into financial derivatives to hedge against forward price risk. These derivatives are recorded at fair value with an offset to regulatory assets and liabilities through our BGSS, subject to BPU approval (See Notes 3 and 4 to the financial statements). We adjust the fair value of the contracts each reporting period for changes in the market.
As discussed in Notes 13 and 14 of the financial statements, energy-related derivative instruments are traded in both exchange-based and non-exchange-based markets. Exchange-based contracts are valued using unadjusted quoted market sources in active markets and are categorized in Level 1 in the fair value hierarchy established by FASB ASC Topic 820 - “Fair Value Measurements and Disclosures.” Certain non-exchange-based contracts are valued using indicative non-binding price quotations available through brokers or from over-the-counter, on-line exchanges and are categorized in Level 2. These price quotations reflect the average of the bid-ask mid-point prices and are obtained from sources that management believes provide the most liquid market. Management reviews and corroborates the price quotations with at least one additional source to ensure the prices are observable market information, which includes consideration of actual transaction volumes, market delivery points, bid-ask spreads and contract duration. Derivative instruments that are used to limit our exposure to changes in interest rates on variable-rate, long-term debt are valued using quoted prices on commonly quoted intervals, which are interpolated for periods different than the quoted intervals, as inputs to a market valuation model. Market inputs can generally be verified and model selection does not involve significant management judgment, as a result, these instruments are categorized in Level 2 in the fair value hierarchy. For non-exchange-based derivatives that trade in less liquid markets with limited pricing information, model inputs generally would include both observable and unobservable inputs. In instances where observable data is unavailable, management considers the assumptions that market participants would use in valuing the asset or liability. This includes assumptions about market risks such as liquidity, volatility and contract duration. Such instruments are categorized in Level 3 in the fair value hierarchy as the model inputs generally are not observable. Counterparty credit risk, and the credit risk of SJG, is incorporated and considered in the valuation of all derivative instruments as appropriate. The effect of counterparty credit risk and the credit risk of SJG on the derivative valuations is not significant.
Environmental Remediation Costs - We estimate future costs based on projected investigation and work plans using existing technologies. In preparing financial statements, we record liabilities for future costs using the lower end of the range because a single reliable estimation point is not feasible due to the amount of uncertainty involved in the nature of projected remediation efforts and the long period over which remediation efforts will continue. We update estimates each year to take into account past efforts, changes in work plans, remediation technologies, government regulations and site specific requirements (See Note 12 to the financial statements).
Pension and Other Postretirement Benefit Costs - The costs of providing pension and other postretirement employee benefits are impacted by actual plan experience as well as assumptions of future experience. Employee demographics, plan contributions, investment performance, and assumptions concerning mortality, return on plan assets, discount rates and health care cost trends all have a significant impact on determining our projected benefit obligations. We evaluate these assumptions annually and adjust them accordingly. These adjustments could result in significant changes to the net periodic benefit costs of providing such benefits and the related liabilities recognized by us.
Pension contributions in both 2009 and 2010, coupled with improvements in equity markets during 2009 reduced the cost of providing such benefits in 2010, despite a 50 basis point decrease in the expected return on plan assets.
Continued improvements in the equity markets through 2010 allowed the cost of the employee pension and other postretirement benefit plans to decrease even further, partially offset by the negative effect of decreasing discount rates. SJG experienced increases in its officer pension plan, which was also impacted by the lower discount rate. As the officer pension plan contains no assets, it was not afforded the benefit of improvements in the equity markets. Additional information regarding investment returns and assumptions can be found in Pension and Other Postretirement Benefits in Note 11 to the financial statements.
The combination of slowing equity markets and lower discount rates in 2011, which are used in determining plan costs in 2012, are expected to increase the cost of providing such plans in 2012. However, SJG has taken measures to manage this increase by making a $19.8 million pension plan contribution in January, 2012. As such, the resulting financial impact on the company is not expected to be significant.
Revenue Recognition - Gas revenues are recognized in the period the commodity is delivered to customers. We bill customers monthly at rates approved by the BPU. A majority of our customers have their meters read on a cycle basis throughout the month. As a result, recognized revenues include estimates. For customers that are not billed at the end of each month, we record an estimate to recognize unbilled revenues for gas delivered from the date of the last meter reading to the end of the month. Our unbilled revenue is estimated each month based on natural gas delivered monthly into the system; unaccounted for natural gas based on historical results; customer-specific use factors, when available; actual temperatures during the period; and applicable customer rates.
The BPU allows us to recover gas costs in rates through the Basic Gas Supply Service (BGSS) price structure. We defer over/under recoveries of gas costs and include them in subsequent adjustments to the BGSS rate. These adjustments result in over/under recoveries of gas costs being included in rates during future periods. As a result of these deferrals, utility revenue recognition does not directly translate to profitability. While we realize profits on gas sales during the month of providing the utility service, significant shifts in revenue recognition may result from the various recovery clauses approved by the BPU. This revenue recognition process does not shift earnings between periods, as these clauses only provide for cost recovery on a dollar-for-dollar basis (See Notes 3 and 4 to the financial statements).
In January 2010, the BPU approved an extension of the Conservation Incentive Program (CIP) through 2013. Each CIP year begins October 1 and ends September 30 of the subsequent year. On a monthly basis during the CIP year, we record adjustments to earnings based on weather and customer usage factors, as incurred. Subsequent to each year, we make filings with the BPU to review and approve amounts recorded under the CIP. BPU approved cash inflows or outflows generally will not begin until the next CIP year and have no impact on earnings at that time.
New Accounting Pronouncements - See detailed discussions concerning New Accounting Pronouncements and their impact in Note 1 to the financial statements.
Rates and Regulation - As a public utility, we are subject to regulation by the New Jersey Board of Public Utilities (BPU). Additionally, the Natural Gas Policy Act, which was enacted in November 1978, contains provisions for Federal regulation of certain aspects of our business. We are affected by Federal regulation with respect to transportation and pricing policies applicable to pipeline capacity from Transcontinental Gas Pipeline Corporation (our major supplier), Columbia Gas Transmission Corporation and Dominion Transmission, Inc., since such services are provided under rates and terms established under the jurisdiction of the FERC. Our retail sales are made under rate schedules within a tariff filed with, and subject to the jurisdiction of, the BPU. These rate schedules provide primarily for either block rates or demand/commodity rate structures. Our primary rate mechanisms include base rates, the Basic Gas Supply Service Clause, Capital Investment Recovery Tracker, Energy Efficiency Tracker and the Conservation Incentive Program.
Effective September 17, 2010, the BPU granted SJG a base rate increase of $42.1 million, which was predicated, in part, upon a 8.21% rate of return on rate base that included a 10.3% return on common equity. The $42.1 million includes $16.6 million of revenue previously recovered through the Conservation Incentive Program (CIP) and $6.8 million of revenues previously recovered through the Capital Investment Recovery Tracker (CIRT), resulting in incremental revenue of $18.7 million. SJG was permitted to recover regulatory assets contained in its petition and is allowed to defer certain federally mandated pipeline integrity management program costs for recovery in its next base rate case. In addition, annual depreciation expense will be reduced by $1.2 million as a result of the amortization of excess cost of removal recoveries. The BPU also authorized a Phase II of the rate proceeding to address the recovery of investment in CIRT not rolled into rate base in this case.
In April 2009, the BPU approved the Capital Investment Recovery Tracker (CIRT), an accelerated infrastructure investment program and an associated rate tracker, which allowed SJG to accelerate $103.0 million of capital spending into 2009 and 2010. As stated above, the BPU authorized a Phase II of its rate case proceeding to address the recovery of investments in CIRT not rolled into rate base in its September 2010 rate case settlement. The CIRT allows SJG to earn a return of, and return on, investment as the capital is spent. In March 2011, the BPU approved an extension of the Capital Investment Recovery Tracker (CIRT II) allowing SJG to accelerate $60.3 million of capital spending into 2011 and 2012. Under CIRT II, the Company capitalizes a return on CIRT II investments until they are recovered in rate base as utility plant in service.
The Conservation Incentive Program (CIP) is a BPU approved pilot program that is designed to eliminate the link between our profits and the quantity of natural gas we sell, and to foster conservation efforts. With the CIP, our profits are tied to the number of customers we serve and how efficiently we serve them, thus allowing us to focus on encouraging conservation and energy efficiency among our customers without negatively impacting our net income. The CIP tracking mechanism adjusts earnings based on weather, and also adjusts our earnings when actual usage per customer experienced during an annual period varies from an established baseline usage per customer. In January 2010, the BPU approved an extension of the CIP through September 2013. Under the terms of the settlement, the CIP may be extended for a one year period in the absence of a Board order taking any affirmative action to the contrary with regard to the pilot program.
Utility earnings are recognized during current periods based upon the application of the CIP. The cash impact of variations in customer usage will result in cash being collected from, or returned to, customers during the subsequent CIP year, which runs from October 1 to September 30.
The effects of the CIP on our net income for the last three years and the associated weather comparisons were as follows ($’s in millions):
As part of the CIP, we are required to implement additional conservation programs including customized customer communication and outreach efforts, targeted upgrade furnace efficiency packages, financing offers, and an outreach program to speak to local and state institutional constituents. We are also required to reduce gas supply and storage assets and their associated fees. Note that changes in fees associated with supply and storage assets have no effect on our net income as these costs are passed through directly to customers on a dollar-for-dollar basis.
Earnings accrued and payments received under the CIP are limited to a level that will not cause our return on equity to exceed 10.3% (excluding earnings from off-system gas sales and certain other tariff clauses) and the annualized savings attained from reducing gas supply and storage assets.
See additional detailed discussions on Rates and Regulatory Actions in Note 3 to the financial statements.
Environmental Remediation - See detailed discussion concerning Environment Remediation in Note 12 to the financial statements.
Competition - Our franchises are non-exclusive. Currently, no other utility provides retail gas distribution services within our territory. We do not expect any other utilities to do so in the foreseeable future because of the extensive investment required for utility plant and related costs. We compete with oil, propane and electricity suppliers for residential, commercial and industrial users, with alternative fuel source providers (wind, solar and fuel cells) based upon price, convenience and environmental factors, and with other marketers/brokers in the selling of wholesale natural gas services. The market for natural gas commodity sales is subject to competition due to deregulation. We enhanced our competitive position while maintaining margins by using an unbundled tariff. This tariff allows full cost-of-service recovery, when transporting gas for our customers. Under this tariff, we profit from transporting, rather than selling, the commodity. Our residential, commercial and industrial customers can choose their supplier while we recover the cost of service through transportation service (see Customer Choice Legislation below).
Customer Choice Legislation - All residential natural gas customers in New Jersey can choose their natural gas commodity supplier under the terms of the “Electric Discount and Energy Competition Act of 1999.” This bill created the framework and necessary time schedules for the restructuring of the state’s electric and natural gas utilities. The Act established unbundling, where redesigned utility rate structures allow natural gas and electric consumers to choose their energy supplier. It also established time frames for instituting competitive services for customer account functions and for determining whether basic gas supply services should become competitive. Customers purchasing natural gas from a provider other than the local utility (marketer) are charged for the gas costs by the marketer and charged for the transportation costs by the utility. The number of customers purchasing their natural gas from marketers averaged 37,829, 30,152, and 28,379 during 2011, 2010 and 2009, respectively.
RESULTS OF OPERATIONS
The following table summarizes the composition of selected gas utility data for the three years ended December 31 (in thousands, except for customer and degree day data):
* Represents expenses for which there is a corresponding credit in operating revenues. Therefore, such recoveries have no impact on our financial results.
Throughput - Total gas throughput increased 17.3 MMdts, or 15.6%, from 2010 to 2011. This increase was realized primarily in the Capacity Release markets. Capacity Release increased 17.1 MMdts during 2011, as compared with 2010, as a result of increased opportunity for such sales. Additional capacity became available during the latter part of 2010 as capacity previously transferred out of SJG under the provisions of the Conservation Incentive Program (CIP) was returned to the utility. Firm throughput decreased 1.7 MMdts, or 3.0%, during 2011, compared with 2010, as a result of 7.8% warmer weather, partially offset by customer growth. The Company added 3,579 customers over the twelve month period ended December 31, 2011, which represents a growth rate of 1.0%.
Total gas throughput increased 12.1 MMdts, or 12.3%, from 2009 to 2010. The majority of the increase is attributable to higher capacity release, which increased by 7.9 MMdts over the prior year, as reflected in the table above. More capacity became available during 2010 as capacity previously transferred out of SJG under the provisions of the CIP were returned to the utility. See additional discussion of the CIP under “Rates and Regulation.” In addition, cogeneration and electric generation sales and transportation throughput increased in 2010. As the summer of 2010 was one of the hottest on record, higher electric consumption for air conditioning drove the demand for greater natural gas consumption by the region’s electric utility. In the cogeneration market, a significant increase in transportation throughput was realized as a single customer increased its contract significantly to shift supply from its alternate pipeline supplier to SJG. Firm throughput also increased moderately due to the addition of 3,956 residential customers in 2010.
Operating Revenues - Revenues decreased $63.5 million, or 13.3%, during 2011, compared with 2010. Firm sales revenue decreased $73.0 million, or 16.7%, during 2011 versus 2010, as the result of lower natural gas costs, which precipitated two customer refunds in 2011 totaling $39.8 million, exclusive of sales tax which does not impact company revenues. The average cost of natural gas purchased during 2011 was $5.94 per dt, representing an 11.3% decrease relative to the average cost of $6.70 per dt during 2010.
While changes in gas costs and BGSS recoveries may fluctuate from period to period, SJG does not profit from the sale of the commodity. Therefore, corresponding fluctuation in Operating Revenue or Cost of Sales have no impact on Company profitability, as further discussed under "Margin."
Warmer weather during the year, primarily during the fourth quarter of 2011, also contributed to lower revenue. Weather was 7.8% warmer than last year and 10.0% warmer than normal.
Partially offsetting the negative impact of lower natural gas costs and warm weather on firm sales revenues was the impact of adding approximately 3,600 customers over the last twelve months, representing 1% growth.
OSS revenue and capacity release revenue increased $6.7 million and $3.4 million, respectively, during 2011 versus 2010, as both sales and capacity release volumetric throughput increased. As previously stated under "Throughput," this was made possible when additional capacity became available during the latter part of 2010, as capacity previously transferred out of SJG under the CIP was returned to SJG. As reflected in the Margin table above, the impact of the higher OSS and capacity release activity during 2011 did not have a material impact on the earnings of the Company, as SJG is required to share 85% of the profits of such activity with the ratepayers.
Revenues decreased $8.4 million, or 1.7%, during 2010 compared with 2009. Firm revenues decreased $6.3 million, or 1.4%, primarily as a result of a lower BGSS rate in effect during 2010. As previously discussed, SJG does not profit from the sale of the commodity. Therefore, corresponding fluctuations in Operating Revenue or Cost of Sales have no impact on Company profitability, as further discussed under “Margin.” There was also a $2.2 million decrease in OSS during 2010 versus 2009. This decrease was primarily related to more volume being marketed as capacity release compared with 2009.
Margin - Our margin is defined as natural gas revenues less natural gas costs; volumetric and revenue based energy taxes; and regulatory rider expenses. We believe that margin provides a more meaningful basis for evaluating utility operations than revenues since natural gas costs, energy taxes and regulatory rider expenses are passed through to customers, and therefore, have no effect on our profitability. Natural gas costs are charged to operating expenses on the basis of therm sales at the prices approved by the New Jersey Board of Public Utilities through our BGSS tariff.
Total margin in 2011 increased $14.5 million, or 7.8%, from 2010 primarily due to a full year of the rate case settlement and approval of CIRT II , both discussed above under “Rates and Regulation,” customer additions and increased firm industrial customer usage. The CIRT programs allow SJG to earn a return on approved infrastructure investments made under these programs.
Approximately $6.8 million of revenues previously recovered through the CIRT were moved into base rates beginning in September 2010, see additional discussion in Note 3 of the Notes to Financial Statements.
The CIP protected $13.3 million of pre-tax margin in 2011 that would have been lost due to lower customer usage, compared to $11.1 million in 2010. Of these amounts, $9.6 million and $1.9 million were related to weather variations and $3.7 million and $9.2 million were related to other customer usage variations in 2011 and 2010, respectively.
Total margin in 2010 increased $17.2 million, or 10.2%, from 2009 primarily due to the rate case settlement discussed above under “Rates and Regulation,” a full year of the Capital Investment Recovery Tracker (CIRT) and customer additions.
The CIP protected $11.1 million of pre-tax margin in 2010 that would have been lost due to lower customer usage, compared to $15.8 million in 2009. Of these amounts, $1.9 million and $1.4 million were related to weather variations and $9.2 million and $14.4 million were related to other customer usage variations in 2010 and 2009, respectively.
Operating Expenses - A summary of changes in other operating expenses (in thousands):
Operations - Operations expense increased $0.9 million during 2011 as compared with 2010. The increases are primarily comprised of the following:
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Spending under the New Jersey Clean Energy Program and Energy Efficiency Programs increased $1.3 million in 2011, compared with 2010. Such costs are recovered on a dollar-for-dollar basis; therefore, SJG experienced an offsetting increase in revenues during 2011.
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Amortization of previously deferred regulatory expenses increased $0.8 million during 2011, compared with 2010. Recovery of these costs was approved in the Company's September 2010 rate case settlement; therefore, such cost recognition is offset by a corresponding increase in revenue.
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Corporate support, governance and compliance costs, primarily attributable to our parent, SJI, increased $1.3 million during 2011, compared with 2010.
Partially offsetting the expense increases noted above was a $1.5 million decrease in SJG's reserve for uncollectible accounts. Changes in the uncollectible reserve are the result of fluctuations in levels of customer accounts receivable balances, which were lower as of December 31, 2011 due to a very warm winter season and a $20.0 million customer bill credit during December 2011. In addition, SJG benefited from a $1.1 million decrease in its reserve for pending litigation due to successful outcomes in various matters during 2011.
Operations expense increased $4.7 million during 2010, as compared with 2009. The increases are primarily comprised of the following:
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Expense associated with the write-off of uncollectible customer accounts receivable increased $1.1 million in 2010, as compared with 2009. This increase in write-offs resulted from an increase in the aging of receivables.
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SJG also increased its reserve for uncollectible accounts, resulting in $0.4 million of additional expense in 2010, as compared to 2009. Changes in the uncollectible reserve are the result of fluctuations in levels of customer accounts receivable balances, which are higher as of December 31, 2010 due to a colder winter season.
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Higher bank fees required to support credit availability and the Company’s variable-rate debt contributed an incremental $0.7 million of additional cost in 2010.
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Payroll expense increased $1.1 million for 2010, as compared with 2009. This was the result of annual compensation increases, additional overtime required to address the impact of unusually inclement weather on the Company’s distribution system, and a voluntary separation program offered in the early part of 2010 to our unionized workforce in an effort to reduce future labor costs.
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SJG also experienced a $0.7 million increase in expense associated with corporate support, governance and compliance costs, primarily attributable to our parent, SJI, in 2010.
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Spending under the New Jersey Clean Energy Program and Energy Efficiency Programs experienced a net increase $0.4 million in 2010, as compared to 2009. As previously stated, such costs are recovered on a dollar-for-dollar basis; therefore, SJG experienced an offsetting increase in revenues during 2010.
Maintenance - Maintenance expense increased $1.6 million during 2011, compared with 2010, due to the BPU-approved amortization and recovery of previously deferred maintenance costs, primarily those associated with a federally mandated pipeline integrity management program. Such amortizations, which are being recovered through an offsetting amount in revenues beginning in September 2010, increased $1.0 million during 2011. The impact of a hurricane and flooding during the third quarter of 2011 resulted in additional costs compared with 2010. The Company also incurred increased maintenance costs in other areas of operations; however, these increases were partially offset by lower levels of Remediation Adjustment Clause (RAC) amortization. As discussed in Notes 3 and 4 to the Financial Statements, RAC costs are recovered from ratepayers; therefore, SJG experienced an offsetting change in revenue during the year.
Maintenance expense increased $2.7 million during 2010, compared with 2009, primarily due to a $1.7 million increase in Remediation Adjustment Clause (RAC) expense amortization. The majority of the difference is associated with regulatory deferrals and amortizations of costs approved in SJG’s recent rate case settlement. SJG experienced an increase in revenue to offset the BPU-approved amortizations of expense.
Depreciation - Depreciation expense increased $1.0 million and $2.5 million in 2011 and 2010, respectively, due mainly to our continuing investment in utility plant. SJG’s investment in utility plant during 2011, 2010 and 2009 was $142.6 million, $115.5 million and $98.7 million, respectively. The increased spending in recent years was a direct result of the State’s stimulus efforts, which included the approval of SJG’s Capital Investment Recovery Tracker, as discussed under “Rates and Regulation.” Partially offsetting the 2011 increase in depreciation expense is an annual credit of $1.2 million. This credit represents the return of excess plant removal costs previously recovered through depreciation rates charges to customers, as agreed upon in SJG's September 2010 base rate case settlement.
Energy and Other Taxes - Energy and Other Taxes decreased $0.5 million during 2011, compared with 2010, primarily due to lower taxable firm throughput in 2011. This resulted from weather that was 7.8% warmer than last year, partially offset by the impact of a 1.0% increase in the number of customers served over the twelve month period ended December 31, 2011. Additional weather information can be found above under the caption "Conservation Incentive Program (CIP)."
Energy and Other Taxes decreased $0.1 million during 2010, compared with 2009, primarily due to lower taxable firm throughput in 2010. While total throughput increased, as previously discussed under “Throughput,” each market experiencing a significant increase in throughput is exempt from utility energy taxes. Therefore, a corresponding increase in energy and other taxes did not result.
Other Income and Expense - Other Income and Expense increased $2.9 million during 2011, compared with 2010. With the approval of the Company's CIRT II in March 2011, the Company is permitted to recognize interest on construction on its qualified incremental spending. While the debt-related component of the interest charge is credited against interest charges, the equity-related component of the interest charge is recognized as Other Income. This incremental income totaled $1.1 million during 2011. In addition, SJG recognized a gain of $0.6 million on the sale of certain available-for-sale securities during the first quarter of 2011. Other Income was negatively impacted during 2010 as a result of a $0.7 million settlement reached with the Federal Energy Regulatory Commission (FERC) to resolve an outstanding dispute. Additional details concerning this settlement can be found in Item 8.01, Other Events, of SJI’s Form 8-K filed on September 28, 2010.
Other income and expense was $0.8 million lower in 2010, when compared with 2009, primarily due to an agreement reached with the FERC to resolve an outstanding dispute. As previously mentioned, this settlement approximated $0.7 million.
Interest Charges - Interest charges increased $1.3 million during 2011, compared with 2010, primarily due to the issuance of $115.0 million aggregate principal long-term debt issued during 2010 at higher interest rates than the short-term debt previously used to finance our capital program through most of 2010. This was partially offset by the positive impact of retiring $25.0 million of SJG's higher priced long-term debt during 2011.
Interest charges increased $1.2 million in 2010, compared with 2009. The effect of lower average levels of short-term debt and lower average short-term debt interest rates was offset by the issuance of $115.0 million aggregate principal long-term debt issued during 2010.
LIQUIDITY AND CAPITAL RESOURCES:
Liquidity needs are driven by factors that include natural gas commodity prices; the impact of weather on customer bills; lags in fully collecting gas costs from customers under the Basic Gas Supply Service charge; the timing of construction and remediation expenditures and related permanent financings; mandated tax payment dates; both discretionary and required repayments of long-term debt; and the amounts and timing of dividend payments.
Cash Flows from Operating Activities - Cash generated from operating activities constitutes our primary source of liquidity and varies from year-to-year due to the impact of weather on customer demand and related gas purchases, customer usage factors related to conservation efforts and the price of the natural gas commodity, inventory utilization and recoveries provided through our various rate mechanisms. Net cash provided by operating activities was $110.5 million in 2011, $112.6 million in 2010 and $122.9 million in 2009.
Cash provided by operating activities declined slightly in 2011 as compared with 2010 primarily as a result of two BGSS bill credits posted to customer accounts in March and December which totaled $39.8 million, and higher planned environmental remediation costs in 2011. These factors offset the working capital benefits of continued lower natural gas costs and lower demand due to milder weather during the fourth quarter of 2011.
Cash provided by operating activities declined in 2010 as compared with 2009 due to higher accounts receivable balances at the end of 2010 caused by the impact of cold weather on natural gas demand; higher prepaid taxes due to a late year tax law change; higher planned environmental remediation costs in 2010; and high levels of cash produced in 2009 from the liquidation of high priced natural gas in inventory was not repeated in 2010. These factors more than offset an improved recovery of gas costs from customers under our BGSS clause and higher accounts payable due to gas costs associated with the increased weather related demand at year end 2010.
Cash Flows from Investing Activities - We have a continuing need for cash resources for capital purchases, primarily to invest in new and replacement facilities and equipment. Cash used for capital expenditures was $142.6 million, $115.5 million and $98.7 million in 2011, 2010 and 2009, respectively, primarily due to infrastructure improvements that continue to support SJG’s growth. The increased capital expenditures during the past three years were the direct result of the Company’s CIRT program which began in 2009. See additional details under “Rates and Regulation.”
For capital expenditures, including those under the CIRT, SJG will use short-term borrowings under both our commercial paper program and lines of credit from commercial banks to finance capital expenditures as incurred. From time to time, the Company will refinance the short-term debt incurred to support capital expenditures with long-term debt.
Cash Flows from Financing Activities - We use short-term borrowings under both our commercial paper program and lines of credit from commercial banks to supplement cash from operations, to support working capital needs and to finance capital expenditures as incurred. From time to time, we refinance short-term debt incurred to finance capital expenditures with long-term debt. Debt is incurred primarily to expand and upgrade our gas transmission and distribution system and to support seasonal working capital needs related to inventories and customer receivables.
Credit facilities and available liquidity as of December 31, 2011 were as follows (in thousands):
(A) A new revolving credit facility was established by SJG in May 2011. The SJG facility is a $200.0 million, four-year facility, provided by a syndicate of banks. The revolving credit facility contains one financial covenant limiting the ratio of indebtedness to total capitalization (as defined in the credit agreement) to not more than 0.65 to 1, measured at the end of each fiscal quarter. SJG was in compliance with this covenant as of December 31, 2011. This facility replaces SJG’s $100.0 million revolving credit facility and $40.0 million committed line of credit, both of which would otherwise have expired in August of 2011.
In July 2011, SJG began a commercial paper program under which SJG may issue short-term, unsecured promissory notes to qualified investors up to a maximum aggregate amount outstanding at any time of $200.0 million. The notes will have fixed maturities which will vary by note, but may not exceed 270 days from the date of issue. Proceeds from the notes will be used for general corporate purposes. SJG intends to use the commercial paper program in tandem with its new $200.0 million revolving credit facility and does not expect the principal amount of borrowings outstanding under the commercial paper program and the credit facility at any time to exceed an aggregate of $200.0 million.
Average borrowings outstanding under these credit facilities during the twelve months ended December 31, 2011 and 2010 were $71.6 million and $89.3 million, respectively. The maximum amount outstanding under these credit facilities during the twelve months ended December 31, 2011 and 2010 were $139.9 million and $130.9 million, respectively.
Based upon the existing credit facilities and a regular dialogue with our banks, we believe there will continue to be sufficient credit available to meet our future liquidity needs.
SJG supplements its operating cash flow and credit lines with both debt and equity capital. Over the years, the Company has used long-term debt, primarily in the form of First Mortgage Bonds and Medium Term Notes (MTN), secured by the same pool of utility assets, to finance our long-term borrowing needs. These needs are primarily capital expenditures for property, plant and equipment. During the third quarter of 2011, SJG entered into an arrangement to issue $35.0 million aggregate principal amount of MTNs under a private placement to occur in April 2012 and repaid $25.0 million of First Mortgage Bonds.
In March, June and December 2010, SJG issued $15.0 million, $45.0 million and $55.0 million aggregate principal amounts, respectively, of its MTNs under private placements. In November 2009, SJG completed an early redemption of $9.9 million of 6.5% bonds due in 2016. We redeemed this debt early to achieve significant interest expense savings due to the low interest rates available to SJG. We repaid long-term debt totaling $25.0 million, $10.0 million and $9.9 million in 2011, 2010 and 2009, respectively.
SJG's $150.0 million Medium Term Note (MTN) program that was approved by the BPU in September 2009 expired in September 2011. In December 2011, SJG received approval from the BPU to issue up to $200.0 million in long-term debt by September 2014.
In February 2012, SJG called its $35.0 million, 7.7% MTN's due April 2027 at par plus a 2% premium. The early redemption will occur concurrently with the issuance of $35.0 million, 3.74% MTN's in April 2012, as discussed in Note 7.
SJI contributed no capital to us in 2011, 2010 or 2009.
As of December 31, our capital structure was as follows:
COMMITMENTS AND CONTINGENCIES:
SJG has a continuing need for cash resources and capital, primarily to invest in new and replacement facilities and equipment, working capital, and for environmental remediation costs. Cash outflows for capital expenditures for the year of 2011 amounted to $142.6 million. Management estimates net cash outflows for construction projects for 2012, 2013 and 2014, to be approximately $134.9 million, $106.0 million and $105.0 million, respectively. Costs for remediation projects, net of insurance reimbursements, for the year of 2011 amounted to net cash outflows of $13.6 million. Total cash outflows for remediation projects are expected to be $18.7 million, $14.5 million and $9.6 million for 2012, 2013, and 2014, respectively. As discussed in Notes 3 and 12 to the Financial Statements in Item 8, environmental remediation costs are subject to recovery from insurance carriers and ratepayers.
STANDBY LETTER OF CREDIT - SJG provided a $25.2 million letter of credit, under a separate credit facility from those it borrows under to provide liquidity support for the remarketing of variable-rate demand bonds issued through the NJEDA. The bonds were used to finance the expansion of SJG’s natural gas distribution system as discussed in Note 7 to the financial statements. As of December 31, 2010, these bonds were included in the current portion of long-term debt because this letter of credit expired during 2011. The replacement letter of credit expires in August 2015, and as a result, the related bonds are now included in long-term debt as of December 31, 2011.
We have certain commitments for both pipeline capacity and gas supply for which we pay fees regardless of usage. Those commitments as of December 31, 2011, average $44.5 million annually and total $207.2 million over the contracts’ lives. Approximately 37% of the financial commitments under these contracts expire during the next five years. We expect to renew each of these contracts under renewal provisions as provided in each contract. We recover all prudently incurred fees through rates via the Basic Gas Supply Service clause.
In addition, in the normal course of business, SJG has entered into long-term contracts for natural gas supplies. SJG has committed to purchase a minimum of 6,250 dts/d and up to 25,000 dts/d of natural gas, from one supplier, for a term of eight years at index-based prices. The obligation for this purchase has not been included in the Company's contractual obligations discussed below because the actual volumes and prices are not fixed.
The following table summarizes our contractual cash obligations and their applicable payment due dates as of December 31, 2011 (in thousands):
Expected environmental remediation costs, asset retirement obligations and the liability for unrecognized tax benefits are not included in the table above as the total obligation cannot be calculated due to the subjective nature of these costs and timing of anticipated payments. SJG made contributions to its employee pension plans totaling $19.8 million in January 2012. However, future pension contributions beyond 2012 cannot be determined at this time. Our regulatory obligation to contribute $3.6 million annually to our postretirement benefit plans’ trusts, as discussed in Note 11 to the financial statements, is also not included as its duration is indefinite.
Off-Balance Sheet Arrangements - We have no off-balance sheet financing arrangements.
Pending Litigation - SJG is subject to claims which arise in the ordinary course of business and other legal proceedings. We accrue liabilities related to these claims when we can reasonably estimate the amount or range of amounts of probable settlement costs or other charges for these claims. The Company has accrued approximately $0.2 million and $1.4 million related to all claims in the aggregate, as of December 31, 2011 and 2010, respectively. Management does not believe that it is reasonably possible that there would be a material change in the Company's estimated liability in the near term and does not currently anticipate the disposition of any known claims to have a material effect on our financial position, results of operations or liquidity.
Item 7a.
Item 7a. Quantitative and Qualitative Disclosures about Market Risks
MARKET RISKS:
Commodity Market Risks - We are involved in buying, selling, transporting and storing natural gas and are subject to market risk due to price fluctuations. To hedge against this risk, we enter into a variety of physical and financial transactions including forward contracts, futures and options agreements. To manage these transactions, we have a well-defined risk management policy approved by our Board of Directors that includes volumetric and monetary limits. Management reviews reports detailing activity daily. Generally, the derivative activities described above are entered into for risk management purposes.
We transact commodities on a physical basis and typically do not enter into financial derivative positions directly. South Jersey Resources Group, LLC, (SJRG) an affiliate by common ownership, manages our risk by entering into the types of transactions noted above. As part of our gas purchasing strategy, we use financial contracts to hedge against forward price risk. These contracts are recoverable through our BGSS, subject to BPU approval. It is management’s policy, to the extent practical, within predetermined risk management policy guidelines, to have limited unmatched positions on a deal or portfolio basis while conducting these activities. As a result of holding open positions to a minimal level, the economic impact of changes in value of a particular transaction is substantially offset by an opposite change in the related hedge transaction. The majority of our contracts are typically less than 12-months long. The fair value and maturity of all these energy trading and hedging contracts determined using mark-to-market accounting as of December 31, 2011 is as follows (in thousands):
NYMEX (New York Mercantile Exchange) is the primary national commodities exchange on which natural gas is traded. Basis represents the price of a NYMEX natural gas futures contract adjusted for the difference in price for delivering the gas at another location. Contracted volumes of our NYMEX contracts are 10.1 MMdts with a weighted-average settlement price of $4.40 per dt. Contracted volumes of our Basis contracts are 3.3 MMdts with a weighted-average settlement price of $.53 per dt.
A reconciliation of our estimated net fair value of energy-related derivatives, including energy trading and hedging contracts follows (in thousands):
The change in our derivative position from a $5.0 million liability at December 31, 2010 to a $10.2 million liability at December 31, 2011 is primarily due to the change in value of our financial positions held with SJRG. As of December 31, 2011 the average future price was approximately $4.26 per dt vs. $4.79 per dt as of December 31, 2010.
Interest Rate Risk - Our exposure to interest rate risk relates primarily to short-term, variable-rate borrowings. Short-term, variable-rate debt outstanding at December 31, 2011, was $126.6 million and averaged $71.6 million during 2011. The months where average outstanding variable-rate debt was at its highest and lowest levels were December, at $139.9 million, and April, at $12.7 million. A hypothetical 100 basis point (1%) increase in interest rates on our average variable-rate debt outstanding would result in a $429,000 increase in our annual interest expense, net of tax. The 100 basis point increase was chosen for illustrative purposes, as it provides a simple basis for calculating the impact of interest rate changes under a variety of interest rate scenarios. Over the past five years, the change in basis points (b.p.) of our average monthly interest rates from the beginning to end of each year was as follows: 2011 - 14 b.p. decrease; 2010 - 5 b.p. increase; 2009 - 29 b.p. decrease; 2008 - 317 b.p. decrease; and 2007 - 36 b.p. decrease. As of December 31, 2011, our average borrowing cost, which changes daily, was 0.62%.
We issue long-term debt either at fixed rates or use interest rate derivatives to limit our exposure to changes in interest rates on variable-rate, long-term debt. As of December 31, 2011, the interest costs on all of our long-term debt was either at a fixed-rate or hedged via an interest rate derivative. Consequently, interest expense on existing long-term debt is not significantly impacted by changes in market interest rates.
Item 8.
Item 8. Financial Statements and Supplementary Data
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholder of
South Jersey Gas Company
Folsom, New Jersey
We have audited the accompanying balance sheets of South Jersey Gas Company (the "Company") as of December 31, 2011 and 2010, and the related statements of income, cash flows, changes in common equity and comprehensive income for each of the three years in the period ended December 31, 2011. Our audits also included the financial statement schedule listed in the Index at Item 15(a)2. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material respects, the financial position of South Jersey Gas Company as of December 31, 2011 and 2010, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2011, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
/s/ Deloitte & Touche LLP
Philadelphia, Pennsylvania
February 28, 2012
SOUTH JERSEY GAS COMPANY
STATEMENTS OF INCOME
(In Thousands)
The accompanying notes are an integral part of the financial statements.
SOUTH JERSEY GAS COMPANY
STATEMENTS OF CASH FLOWS
(In Thousands)
The accompanying notes are an integral part of the financial statements.
SOUTH JERSEY GAS COMPANY
BALANCE SHEETS
(In Thousands)
The accompanying notes are an integral part of the financial statements.
SOUTH JERSEY GAS COMPANY
BALANCE SHEETS
(In Thousands, except for share data)
The accompanying notes are an integral part of the financial statements.
SOUTH JERSEY GAS COMPANY
STATEMENTS OF CHANGES IN COMMON EQUITY AND COMPREHENSIVE INCOME
(In Thousands)
(a) Determined using a combined statutory tax rate of 41%.
Disclosure of Changes in Accumulated Other Comprehensive Loss Balances (a)
(In Thousands)
(a) Determined using a combined statutory tax rate of 41%.
The accompanying notes are an integral part of the financial statements.
NOTES TO FINANCIAL STATEMENTS
1.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
The Entity - South Jersey Industries, Inc. (SJI) owns all of the outstanding common stock of South Jersey Gas Company (SJG). In our opinion, the financial statements reflect all normal and recurring adjustments needed to fairly present our financial position and operating results at the dates and for the periods presented.
Equity Investments - Marketable equity securities that are purchased as long-term investments are classified as Available-for-Sale Securities and carried at their fair value on our balance sheets. Any unrealized gains or losses are included in Accumulated Other Comprehensive Loss. An impairment loss is recorded when there is clear evidence that a decline in value is other than temporary. No impairment losses were recorded on Investments during 2011, 2010 or 2009.
Estimates and Assumptions - We prepare our financial statements to conform with accounting principles generally accepted in the United States of America (GAAP). Management makes estimates and assumptions that affect the amounts reported in the financial statements and related disclosures. Therefore, actual results could differ from those estimates. Significant estimates include amounts related to regulatory accounting, energy derivatives, environmental remediation costs, pension and other postretirement benefit costs, and revenue recognition.
Regulation - We are subject to the rules and regulations of the New Jersey Board of Public Utilities (BPU). See Note 3 for a detailed discussion of our rate structure and regulatory actions. We maintain our accounts according to the BPU’s prescribed Uniform System of Accounts. We follow the accounting for regulated enterprises prescribed by the FASB ASC Topic 980 - “Regulated Operations.” In general, Topic 980 allows for the deferral of certain costs (regulatory assets) and creation of certain obligations (regulatory liabilities) when it is probable that such items will be recovered from or refunded to customers in future periods. See Note 4 for a detailed discussion of regulatory assets and liabilities.
Operating Revenues - Gas revenues are recognized in the period the commodity is delivered to customers. For retail customers that are not billed at the end of the month, we record an estimate to recognize unbilled revenues for gas delivered from the date of the last meter reading to the end of the month.
Revenue Based Taxes - We collect certain revenue-based energy taxes from our customers. Such taxes include New Jersey State Sales Tax, Transitional Energy Facility Assessment (TEFA) and Public Utilities Assessment (PUA). State sales tax is recorded as a liability when billed to customers and is not included in revenue or operating expenses. TEFA and PUA are included in both revenues and cost of sales and totaled $8.0 million, $8.6 million and $8.8 million in 2011, 2010 and 2009, respectively.
Accounts Receivable and Provision for Uncollectible Accounts - Accounts receivable are carried at the amount owed by customers. A provision for uncollectible accounts is established based on our collection experience and an assessment of the collectibility of specific accounts.
Natural Gas in Storage - Natural Gas in Storage is reflected at average cost on the balance sheets, and represents natural gas that will be utilized in the ordinary course of business.
Property, Plant & Equipment - For regulatory purposes, utility plant is stated at original cost, which may be different than our cost if the assets were acquired from another regulated entity. The cost of adding, replacing and renewing property is charged to the appropriate plant account. Utility Plant balances as of December 31, 2011 and 2010 were comprised of the following (in thousands):
The increase in Construction Work in Progress is related to projects for information technology and transmission, some of which are part of the Company’s Capital Recovery Tracker (CIRT) program, as discussed under Note 3.
Asset Retirement Obligations - The amounts included under Asset Retirement Obligations (ARO) are primarily related to the legal obligations we have to cut and cap our gas distribution pipelines when taking those pipelines out of service in future years. These liabilities are generally recognized upon the acquisition or construction of the asset. The related asset retirement cost is capitalized concurrently by increasing the carrying amount of the related asset by the same amount as the liability. Changes in the liability are recorded for the passage of time (accretion) or for revisions to cash flows originally estimated to settle the ARO.
ARO activity during 2011 and 2010 was as follows (in thousands):
* The revision in estimated cash flows reflects an increase in the contractual cost to settle the ARO. A corresponding increase was made to regulatory assets, thus having no impact on earnings.
Depreciation - We depreciate utility plant on a straight-line basis over the estimated remaining lives of the various property classes. These estimates are periodically reviewed and adjusted as required after BPU approval. The composite annual rate for all depreciable utility property was approximately 2.3% in 2011, 2.4% in 2010 and 2.3% in 2009. The actual composite rate may differ from the approved rate as the asset mix changes over time. Except for retirements outside of the normal course of business, accumulated depreciation is charged with the cost of depreciable utility property retired, less salvage.
Capitalized Interest - We capitalize interest on construction at the rate of return on rate base utilized by the BPU to set rates in our last base rate proceeding (See Note 3). Capitalized interest is included in Utility Plant on the balance sheets. Interest Charges are presented net of capitalized interest on the statements of income. We capitalized interest of $1.1 million in 2011, $0.4 million in 2010 and $0.3 million in 2009.
Impairment of Long-Lived Assets - We review the carrying amount of long-lived assets for possible impairment whenever events or changes in circumstances indicate that such amounts may not be recoverable. For the years ended 2011, 2010 and 2009, no significant impairments were identified.
Derivative Instruments - SJG, through its affiliate, South Jersey Resources Group (SJRG), uses a variety of derivative instruments to limit its exposure to market risk in accordance with strict guidelines (See Note 14). These contracts, which have not been designated as hedging instruments under GAAP, are measured at fair value and recorded in Derivatives - Energy Related Assets or Derivatives - Energy Related Liabilities on the balance sheets. The costs or benefits of these short-term contracts are recoverable through SJG’s Basic Gas Supply Service (BGSS) clause, subject to BPU approval. As a result, the net unrealized pre-tax gains and losses for these energy related commodity contracts are included with realized gains and losses in Regulatory Assets or Regulatory Liabilities on the balance sheets.
SJG has also entered into interest rate derivatives to hedge exposure to increasing interest rates and the impact of those rates on cash flows of variable-rate debt. These interest rate derivatives, which have not been designated as hedging instruments under GAAP, are measured at fair value and recorded in Derivatives-Other on the balance sheets. The fair value represents the amount SJG would have to pay the counterparty to terminate these contracts as of those dates. Subject to BPU approval, the market value upon termination of these interest rate derivatives can be recovered in rates and, therefore, these unrealized losses have been included in Other Regulatory Assets in the balance sheets.
Income Taxes - Deferred income taxes are provided for all significant temporary differences between the book and taxable basis of assets and liabilities in accordance with FASB ASC Topic 740 - “Income Taxes” (See Note 6). A valuation allowance is established when it is determined that it is more likely than not that a deferred tax asset will not be realized.
Cash and Cash Equivalents - For purposes of reporting cash flows, highly liquid investments with original maturities of three months or less are considered cash equivalents.
NEW ACCOUNTING PRONOUNCEMENTS -Other than as described below, no new accounting pronouncement issued or effective during 2011 and 2010 had, or is expected to have, a material impact on the financial statements.
In May 2011, the FASB issued Accounting Standards Update (ASU) No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS. This ASU amends ASC Topic 820 to include a consistent definition of the term “fair value” and set forth common requirements for measuring fair value and disclosing information about fair value measurements in financial statements. The new guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The adoption of this guidance is not expected to have an impact on our financial statement results.
In June 2011, the FASB issued ASU No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. This ASU allows an entity the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with a total for other comprehensive income, and a total amount for comprehensive income. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. In January 2012, the FASB issued ASU 2011-12, Deferral of the Effective Date for the Presentation of Reclassification Adjustments Out of Accumulated Other Comprehensive Income, which defers the provisions related to the presentation of reclassification adjustments.The other portions of the ASU remain unchanged and will become effective for interim and annual periods beginning after December 15, 2011, with early adoption permitted. The adoption of this guidance will modify our financial statement presentation, but will not have an impact on our financial statement results.
In January 2012, the FASB issued ASU 2011-11, Enhanced Disclosure Requirements Concerning Offsetting of Financial Assets and Financial Liabilities. This ASU amends ASC 210-20 to add disclosure requirements in respect of the offsetting of financial assets and financial liabilities. The new guidance is effective for fiscal years beginning on or after January 1, 2013. Management is currently evaluating the impact that the adoption of this guidance will have on the Company’s financial statements.
2.
STOCK-BASED COMPENSATION PLAN:
Officers and other key employees of SJG participate in the Stock Option, Stock Appreciation Rights and Restricted Stock Award Plan (“Plan”) of SJI. As the vesting requirements under the plan are contingent upon market and service conditions, SJI is required to measure and recognize stock-based compensation expense based on the fair value at the date of grant for share-based awards on a straight-line basis over the requisite service period of each award. In addition, SJI identifies specific forfeitures of share-based awards and compensation expense is adjusted accordingly over the requisite service period. Compensation expense
is not adjusted based on the actual achievement of performance goals. The fair value of Officers’ restricted stock awards on the date of grant is estimated using a Monte Carlo simulation model.
We are allocated a portion of SJI's compensation cost during the vesting period. We accrue a liability and record compensation cost on a straight-line basis over the requisite three-year service period based on the grant date fair value. Upon vesting, we make a cash payment to SJI equal to the amounts accrued as compensation cost during the vesting period. Since the inception of the Plan, our expense recognition policy has been consistent with the expense recognition policy at SJI.
The following table summarizes the SJI nonvested restricted stock awards pertaining to SJG outstanding at December 31, 2011, and the assumptions used to estimate the fair value of the awards:
Expected volatility is based on the actual volatility of SJI’s share price over the preceding 3-year period as of the valuation date. The risk-free interest rate is based on the zero-coupon U.S. Treasury Bond, with a term equal to the 3-year term of the restricted shares. As notional dividend equivalents are credited to the holders, which are reinvested during the 3-year service period, no reduction to the fair value of the award is required.
The cost of restricted stock awards was $0.4 million in the year ended December 31, 2011, and $0.3 million in each of the years ended December 31, 2010 and 2009. Of these costs, $0.2 million was capitalized to Utility Plant in each of those years.
As of December 31, 2011, there was $0.4 million of total unrecognized compensation cost related to nonvested share-based compensation awards granted under the restricted stock plans. That cost is expected to be recognized over a weighted average period of 1.7 years.
The following table summarizes information regarding restricted stock award activity during 2011, excluding accrued dividend equivalents:
*
Actual shares expected to be awarded to SJG officers and other key employees during the first quarter of 2012, including dividend equivalents and adjustments for performance measures, total 7,098 shares.
During 2011, SJG awarded 15,186 shares that had vested at December 31, 2010, to officers and other key employees at a market value of $0.8 million. During 2010, 14,400 shares were awarded to officers and other key employees at a market value of $0.5 million. As discussed earlier, we have a policy of making cash payments to SJI to satisfy our allocated obligations under this plan. Cash payments to SJI during 2011 and 2010, were approximately $0.3 million relative to stock awards. Additionally, a change in control could result in the nonvested shares becoming nonforfeitable or immediately payable in cash.
3.
RATES AND REGULATORY ACTIONS:
Base Rates - SJG is subject to the rules and regulations of the BPU. On September 17, 2010, the BPU granted SJG a base rate increase of $42.1 million, which was predicated, in part, upon a 8.21% rate of return on rate base that included a 10.3% return on common equity. The $42.1 million includes $16.6 million of revenue previously recovered through the Conservation Incentive Program (CIP) and $6.8 million of revenues previously recovered through the Capital Investment Recovery Tracker (CIRT), resulting in incremental revenue of $18.7 million. SJG was permitted to recover regulatory assets contained in its petition and defer certain federally mandated pipeline integrity management program costs for recovery in its next base rate case. In addition, annual depreciation expense will be reduced by $1.2 million as a result of the amortization of excess cost of removal recoveries. The BPU also authorized a Phase II of the base rate proceeding to review the costs of CIRT projects not rolled into rate base in the September 2010 settlement..
Rate Mechanisms - Our tariff, a schedule detailing the terms, conditions and rate information applicable to our various types of natural gas service, as approved by the BPU, has several primary rate mechanisms as discussed in detail below:
Basic Gas Supply Service (BGSS) Clause - The BGSS price structure was approved by the BPU in January 2003, and allows us to recover all prudently incurred gas costs. BGSS charges to customers can be either monthly or periodic (annual). Monthly BGSS charges are applicable to large use customers and are referred to as monthly because the rate changes on a monthly basis pursuant to a BPU-approved formula based on commodity market prices. Periodic BGSS charges are applicable to lower usage customers, which include all of our residential customers, and are evaluated at least annually by the BPU. However, to some extent, more frequent rate changes to the periodic BGSS are allowed. We collect gas costs from customers on a forecasted basis and defer periodic over/under recoveries to the following BGSS year, which runs from October 1 through September 30. If we are in a net cumulative undercollected position, gas costs deferrals are reflected on the balance sheet as a regulatory asset. If we are in a net cumulative overcollected position, amounts due back to customers are reflected on the balance sheet as a regulatory liability. We pay interest on net overcollected BGSS balances at the rate of return on rate base utilized by the BPU to set rates in our last base rate proceeding.
Regulatory actions regarding the BGSS were as follows:
•
June 2009 - We made our annual BGSS filing to the BPU requesting a $54.7 million reduction, or 17.5% decrease, in gas costs recoveries in response to projected decreases in wholesale gas costs.
•
August 2009 - The BPU issued an Order finalizing the 2008-2009 provisional BGSS costs.
•
September 2009 - The BPU approved, on a provisional basis, SJG’s request for a $54.7 million, or 17.5%, reduction in gas cost recoveries.
•
June 2010 - We made our annual BGSS filing to the BPU requesting a $38.0 million, or 13.9%, reduction in gas cost recoveries in response to projected decreases in wholesale gas costs.
•
September 2010 - The BPU approved, on a provisional basis, SJG’s request for a $38.0 million, or 13.9%, reduction in gas cost recoveries.
•
March 2011 - We credited the accounts of our periodic BGSS customers with refunds totaling $21.1 million due to gas costs that were lower than projected during the winter season.
•
June 2011 - We filed our annual BGSS filing with the BPU requesting a $10.6 million, or 2.9%, reduction in rates commencing on October 1, 2011.
•
September 2011 - The BPU issued an Order finalizing the 2010-2011 provisional BGSS rate and approved, on a provisional basis, SJG's request for a $10.6 million, or 2.9%, reduction in gas cost recoveries.
•
December 2011 - We credited the accounts of our periodic BGSS customers with refunds totaling $18.7 million due to gas costs that were lower than projections.
Conservation Incentive Program (CIP) - The primary purpose of the CIP is to promote conservation efforts, without negatively impacting financial stability, and to base our profit margin on the number of customers rather than the amount of natural gas distributed to customers. In October 2006, the BPU approved the CIP as a three-year pilot program. In January 2010, the BPU approved an extension of this program through September 2013. Each CIP year begins October 1 and ends September 30 of the subsequent year. On a monthly basis during the CIP year, we record adjustments to earnings based on weather and customer usage factors, as incurred. Subsequent to each year, we will make filings with the BPU to review and approve amounts recorded under the CIP. BPU approved cash inflows or outflows generally will not begin until the next CIP year.
Regulatory actions regarding the CIP were as follows:
•
June 2009 - We made our annual CIP filing to the BPU requesting recovery of $13.4 million which included a $13.7 million non-weather related recovery, partially offset by a credit of $0.3 million which was weather related.
•
August 2009 - The BPU issued an Order finalizing the 2008-2009 provisional CIP rates.
•
September 2009 - The BPU approved, on a provisional basis, the recovery of CIP revenue of $13.4 million.
•
June 2010 - We made our annual CIP filing to the BPU requesting recovery of $20.0 million which included a $14.4 million non-weather related recovery and $5.6 million which was weather related. The BGSS savings to be applied as an offset to the non-weather related recovery totaled $8.9 million. As a result, SJG will carry forward $5.5 million to be recovered from customers in the next CIP year.
•
September 2010 - The BPU approved, on a provisional basis, the recovery of CIP revenue of $14.5 million.
•
June 2011 - We made our annual CIP filing to the BPU requesting recovery of $2.5 million which includes a $2.7 million credit to customers for the current 2011-2012 CIP year and prior year carryovers of $5.2 million. The CIP credit of $2.7 million includes $1.3 million non-weather related credits and $1.4 million weather related credits.
•
September 2011 - The BPU issued an Order finalizing the 2010-2011 provisional CIP rates and also approved, on a provisional basis, the 2011-2012 CIP rates filed in June 2011, effective October 1, 2011.
Capital Investment Recovery Tracker (CIRT) - In January 2009, we made a filing with the BPU requesting approval for an accelerated infrastructure investment program. The purpose of the CIRT was to accelerate $103.0 million of capital expenditures from five years to two years. The petition requested that we be allowed to earn a return of, and a return on, our investment. Under the CIRT, 2009 spending was projected to be $70.5 million and 2010 spending was projected to be $32.5 million. On a monthly basis during the CIRT year, we record adjustments to earnings based on actual CIRT program expenditures, as incurred. Annually we make a filing to the BPU for review and approval of expenditures recorded under the CIRT.
Regulatory actions regarding the CIRT were as follows:
•
January 2009 - We filed a petition with the BPU for approval of an accelerated infrastructure investment program and associated rate tracker as discussed above.
•
April 2009 - The BPU approved our petition for the CIRT, including a first year estimated capital expenditure level of $70.5 million, and estimated revenue of $3.2 million.
•
November 2009 - We made our annual CIRT filing, requesting $10.6 million in additional revenue.
•
December 2009 - The BPU approved, on a provisional basis, recovery of an additional $9.9 million in CIRT revenue.
•
September 2010 - The BPU authorized $81.3 million of CIRT-related expenditures to be rolled into rate base and also authorized that the remaining balance of CIRT-related expenditures continue to be recovered. These remaining expenditures will be reviewed and rolled into rate base during Phase II of the base rate case in 2011.
•
October 2010 - We made our annual CIRT filing requesting approval to earn a return of, and a return on, $150.0 million in additional CIRT-related expenditures during 2011, 2012 and 2013.
•
March 2011 - The BPU approved a CIRT II program allowing the Company to accelerate an additional $60.3 million of capital spending into 2011 and 2012. Under CIRT II, the Company will continue to earn a return of, and return on, investment as the capital is spent, as it did under the original CIRT.
•
June 2011 - The Company filed a petition with the BPU requesting the recovery of a portion of CIRT II investments via a roll-in to rate base, and requested to increase the base rates by 0.5% effective October 1, 2011. This petition is currently pending.
•
October 2011 - The Company filed a petition with the BPU requesting to modify and extend the CIRT II program. The petition requested an additional incremental investment of $40.0 million in 2012 and $50.0 million in 2013. This petition is currently pending.
Energy Efficiency Tracker (EET) - In January 2009, we filed a petition with the BPU requesting approval of an energy efficiency program for residential, commercial and industrial customers. Under this program we can invest $17.0 million over two years in energy efficiency measures to be installed in customer homes and businesses. We can also recover incremental operating and maintenance expenses and earn a return of, and return on, program investments.
Regulatory actions regarding the EET were as follows:
•
January 2009 - Filed a petition with the BPU for approval of an energy efficiency program as noted above, with a projected 2009 revenue of $1.7 million.
•
July 2009 - The BPU approved our petition for the EET with a revenue recovery of $1.3 million.
•
July 2010 - Filed a petition with the BPU requesting a reallocation of investment dollars between the EET programs to fund the more popular programs.
•
November 2010 - Filed a petition with the BPU requesting a one year extension of the program.
•
January 2011 - SJG’s request to reallocate investment dollars between the programs and a one year extension was approved by the BPU.
•
June 2011 - The Company filed its annual 2011-2012 petition requesting approval of a $5.8 million increase in EET recovery. This petition is currently pending.
•
October 2011 - The Company filed a petition requesting a modification of the EET with regards to the Combined Heat and Power (CHP) program. The BPU approved this petition in February 2012.
Societal Benefits Clause (SBC) - The SBC allows us to recover costs related to several BPU-mandated programs. Within the SBC are a Remediation Adjustment Clause (RAC), a New Jersey Clean Energy Program (NJCEP), a Universal Service Fund (USF) program and a Consumer Education Program (CEP).
Regulatory actions regarding the SBC, with the exception of USF which requires separate regulatory filings, were as follows:
•
January 2009 - We made our annual 2008-2009 SBC filing requesting a $7.9 million increase in SBC recoveries.
•
August 2009 - We made our annual 2009-2010 SBC filing requesting a $15.5 million increase in SBC recoveries.
•
September 2010 - We made our annual 2010-2011 SBC filing requesting a $21.5 million increase in SBC recoveries. This petition is pending.
•
July 2011 - We made our annual 2011-2012 SBC filing requesting a $31.2 million increase in SBC recoveries. This petition is pending.
•
September 2011 - The BPU finalized rates for the 2008-2009 and 2009-2010 SBC petitions.
Remediation Adjustment Clause (RAC) - The RAC recovers environmental remediation costs of 12 former gas manufacturing plants (See Note 12). The BPU allows us to recover such costs over 7-year amortization periods. The net between the amounts actually spent and amounts recovered from customers is recorded as a regulatory asset, Environmental Remediation Cost Expended - Net. Note that RAC activity affects revenue and cash flows but does not directly affect earnings because of the cost recovery over 7-year amortization periods. As of December 31, 2011 and 2010, we reflected the unamortized remediation costs of $45.8 million and $39.1 million, respectively, on the balance sheet under Regulatory Assets (See Note 4). Since implementing the RAC in 1992, we have recovered $58.6 million through rates.
New Jersey Clean Energy Program (NJCEP) - This mechanism recovers costs associated with our energy efficiency and renewable energy programs. In August 2008, the BPU approved the statewide funding of the NJCEP of $1.2 billion for the years 2009 through 2012. Of this amount, we will be responsible for approximately $41.5 million over the 4-year period. NJCEP adjustments affect revenue and cash flows but do not directly affect earnings as related costs are deferred and recovered through rates on an on-going basis.
Universal Service Fund (USF) - The USF is a statewide program through which funds for the USF and Lifeline Credit and Tenants Assistance Programs are collected from customers of all New Jersey electric and gas utilities. USF adjustments affect cash flows but do not directly affect revenue or earnings as related costs are deferred and recovered through rates on an ongoing basis.
Separate regulatory actions regarding the USF were as follows:
•
June 2009 - We made our annual USF filing, along with the state’s other electric and gas utilities, proposing to decrease annual statewide gas revenues by $39.1 million. This proposal was designed to decrease our annual USF revenue by $4.9 million.
•
October 2009 - The BPU approved the statewide budget of $60.1 million for all of the State’s gas utilities. Our portion of this total is approximately $5.1 million and decreased rates were implemented effective October 12, 2009, resulting in a $4.1 million decrease to our annual USF recoveries.
•
July 2010 - We made our annual USF filing, along with the state’s other electric and gas utilities, proposing to increase annual statewide gas revenues by $3.4 million. This proposal was designed to increase our annual USF revenue by $0.4 million.
•
August 2010 - We updated our July 2010 filing to reflect actual data through June 2010.
•
October 2010 - The BPU approved the statewide budget of $64.8 million for all of the State’s gas utilities. Our portion of the total is approximately $6.6 million and increased rates were implemented effective November 1, 2010, resulting in a $0.4 million increase to our annual USF recoveries.
•
June 2011 - We made our annual USF filing, along with the state's other electric and gas utilities, proposing to decrease annual statewide gas revenues by $9.3 million. This proposal was designed to decrease our annual USF revenue by $0.8 million.
•
October 2011 - The BPU approved the statewide budget of $57.4 million for all of the State's gas utilities. Our portion of the total is approximately $5.4 million, which decreased rates effective November 1, 2011, resulting in a $0.5 million decrease to our annual USF recoveries.
Other Regulatory Matters -
Unbundling - Effective January 10, 2000, the BPU approved full unbundling of our system. This allows all natural gas consumers to select their natural gas commodity supplier. As of December 31, 2011, 35,880 of our customers were purchasing their gas commodity from someone other than us. Customers choosing to purchase natural gas from providers other than the utility are charged for the cost of gas by the marketer. The resulting decrease in our revenues is offset by a corresponding decrease in gas costs. While customer choice can reduce utility revenues, it does not negatively affect our net income or financial condition. The BPU continues to allow for full recovery of prudently incurred natural gas costs through the BGSS. Unbundling did not change the fact that we still recover cost of service, including certain deferred costs, through base rates.
Pipeline Integrity - In October 2005, we filed a petition with the BPU to implement a Pipeline Integrity Management Tracker (Tracker). The purpose of this Tracker was to recover incremental costs to be incurred by us as a result of new federal regulations, which are aimed at enhancing public safety and reliability. The regulations require that utilities use a comprehensive analysis to assess, evaluate, repair and validate the integrity of certain transmission lines in the event of a leak or failure. As part of our September 2010 base rate increase, we were permitted to recover previously deferred pipeline integrity costs incurred through September 2010. In addition, we are authorized to defer future program costs, including related carrying costs, for recovery in our next base rate proceeding, subject to review by the BPU. Accordingly, SJG withdrew its petition for the Pipeline Integrity Management Tracker. As of December 31, 2011 and 2010, deferred pipeline integrity costs totaled $1.2 million and $1.7 million, respectively, and are included in other regulatory assets (See Note 4).
Filings and petitions described above are still pending unless otherwise indicated.
4.
REGULATORY ASSETS AND LIABILITIES:
The discussion under Note 3, Rates and Regulatory Actions, is integral to the following explanations of specific regulatory assets and liabilities.
Regulatory Assets at December 31 consisted of the following items (in thousands):
Except where noted below, all regulatory assets are or will be recovered through utility rate charges, as detailed in the following discussion. We are currently permitted to recover interest on our Environmental Remediation Costs and Societal Benefit Costs Receivable, while the other assets are being recovered without a return on investment.
Environmental Remediation Costs - We have two regulatory assets associated with environmental costs related to the cleanup of 12 sites where we or our predecessors previously operated gas manufacturing plants. The first asset, Environmental Remediation Cost: Expended - Net, represents what was actually spent to clean up the sites, less recoveries through the RAC and insurance carriers. These costs meet the deferral requirements of GAAP, as the BPU allows us to recover such expenditures through the RAC. The other asset, Environmental Remediation Cost: Liability for Future Expenditures, relates to estimated future expenditures required to complete the remediation of these sites. We recorded this estimated amount as a regulatory asset with the corresponding current and noncurrent liabilities on the balance sheets under the captions Current Liabilities and Regulatory and Other Noncurrent Liabilities. The BPU allows us to recover the deferred costs over seven-year periods after they are spent.
Income Taxes - Flowthrough Depreciation - This regulatory asset represents unamortized excess tax depreciation over book depreciation on utility plant because of temporary differences for which, prior to 1993, deferred taxes previously were not provided. We previously passed these tax benefits through to ratepayers and recovered the amortization of the regulatory asset through rates until 2011.
Deferred Asset Retirement Obligation Costs - This regulatory asset resulted from the recording of asset retirement obligations (ARO) and additional utility plant, primarily related to a legal obligation we have for certain safety requirements upon the retirement of our gas distribution and transmission system. We recover asset retirement costs through rates charged to customers. All related accumulated accretion and depreciation amounts for these ARO represent timing differences in the recognition of retirement costs that we are currently recovering in rates and, as such, we are deferring such differences as regulatory assets.
Deferred Pension and Other Postretirement Benefit Costs - The BPU authorized us to recover costs related to postretirement benefits under the accrual method of accounting consistent with GAAP. We deferred amounts accrued prior to that authorization and are amortizing them as allowed by the BPU over 15 years through 2012. The unamortized balance was $0.4 million at December 31, 2011. In 2006, our regulatory asset was increased by $37.1 million representing the recognition of the underfunded positions of our pension and other postretirement benefit plans. Subsequent adjustments to this balance occur annually to reflect changes in the funded positions of these benefit plans caused by changes in actual plan experience as well as assumptions of future experience (See Note 11).
Deferred Gas Costs - Net - Over/under collections of gas costs are monitored through our BGSS mechanism. Net undercollected gas costs are classified as a regulatory asset and net overcollected gas costs are classified as a regulatory liability. Derivative contracts used to hedge our natural gas purchases are also included in the BGSS, subject to BPU approval. See detailed discussion under Derivative Instruments in Notes 1 and 14.
Conservation Incentive Program Receivable - The impact of the CIP is recorded as an adjustment to earnings as incurred. The first year of cash recovery under the CIP began October 2007.
Societal Benefit Costs Receivable - At both December 31, 2011 and 2010, this regulatory asset primarily represents cumulative costs less recoveries under the USF program.
Premium for Early Retirement of Debt - At December 31, 2011, this regulatory asset represents unamortized debt issuance costs related to long-term debt refinancings and at December 31, 2010 it also included a call premium of $0.2 million associated with the retirement of debt, all occurring in 2005 and 2004. Unamortized debt issuance costs are being amortized over the term of the new debt issue pursuant to regulatory approval by the BPU. As part of our September 2010 base rate increase, the call premium was transferred to unamortized debt issuance costs and is being amortized over the term of the new debt issue.
Deferred Interest Rate Contracts - These amounts represent the market value of interest rate derivatives as discussed further in Note 14.
Other Regulatory Assets - Some of the assets included in Other Regulatory Assets are currently being recovered from ratepayers as approved by the BPU. Management believes the remaining deferred costs are probable of recovery from ratepayers through future utility rates.
Regulatory Liabilities at December 31 consisted of the following items (in thousands):
Excess Plant Removal Costs - Represents amounts accrued in excess of actual utility plant removal costs incurred to date. As part of our September 2010 base rate increase, we are required to start amortizing approximately $1.2 million of this balance to depreciation expense each year.
Deferred Revenues - Net - See previous discussion under “Deferred Gas Costs - Net”.
Other Regulatory Liabilities - All other regulatory liabilities are subject to being returned to ratepayers in future rate proceedings.
5.
RELATED PARTY TRANSACTIONS:
We conducted business with our parent, SJI, and several other related parties. A description of each of these affiliates and related transactions is as follows:
SJI Services, LLC (SJIS) - a wholly owned subsidiary of SJI, provides services, such as information technology, human resources, government relations, corporate communications, materials purchasing and fleet management to SJI and all of its subsidiaries.
South Jersey Energy Solutions, LLC (SJES) - a wholly owned subsidiary of SJI that serves as a holding company for all of SJI’s nonutility operating businesses:
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South Jersey Energy Company (SJE) - a wholly owned subsidiary of SJI and a third party energy marketer that acquires and markets natural gas and electricity to retail end users and provides total energy management services to commercial and industrial customers. We previously sold natural gas for resale to SJE and also provide them with billing services. For SJE’s residential customers, for which we perform billing services, we purchase the related accounts receivable at book value less a factor for potential uncollectible accounts, and assume all risk associated with collection.
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South Jersey Resources Group, LLC (SJRG) - a wholly owned subsidiary of SJI and a wholesale gas and risk management business that supplies natural gas storage, commodity and transportation to retail marketers, utility businesses and electricity generators in the mid-Atlantic, Appalachian and southern states. We sell natural gas for resale and capacity release to SJRG and also meet some of our gas purchasing requirements by purchasing natural gas from SJRG. Additionally, SJRG manages our market risk associated with fluctuations in the cost of natural gas by entering into financial derivative contracts on our behalf. The gain or loss associated with these derivative contracts is included in our BGSS and in the SJRG receivable and payable amounts shown below
•
Marina Energy LLC (Marina) - a wholly owned subsidiary of SJI and developer, owner and operator of energy related projects. We provide natural gas transportation services to Marina under BPU-approved tariffs.
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South Jersey Energy Service Plus, LLC (SJESP) - a wholly owned subsidiary of SJI and an appliance service and installation of heating and cooling systems company. We provide billing services to SJESP.
Millennium Account Services, LLC (Millennium) - a partnership between SJI and Conectiv Solutions, LLC, which reads our utility customers’ meters on a monthly basis for a fee.
Sales of gas to SJRG and SJE comply with Section 284.02 of the Regulations of the Federal Energy Regulatory Commission (FERC).
In addition to the above, we provide various administrative and professional services to SJI and each of the affiliates discussed above. Likewise, SJI and SJIS provide substantial administrative services on our behalf. For certain types of transactions, we served as central processing agents for the related parties discussed above. Amounts due to and due from these related parties for pass-through items are not considered material to the financial statements as a whole.
A summary of these related party transactions, excluding pass-through items, included in Operating Revenues were as follows (in thousands):
Related party transactions, excluding pass-through items, included in Operating Expenses were as follows (in thousands):
6.
INCOME TAXES AND CREDITS:
Total income taxes applicable to operations differ from the tax that would have resulted by applying the statutory Federal income tax rate to pre-tax income for the following reasons (in thousands):
The provision for Income Taxes is comprised of the following (in thousands):
Investment Tax Credits are deferred and amortized at the annual rate of 3%, which approximates the life of related assets.
The net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting and income tax purposes resulted in the following net deferred tax liabilities at December 31 (in thousands):
SJG is included in the consolidated federal income tax return filed by SJI. The actual taxes, including credits, are allocated by SJI to its subsidiaries, generally on a separate return basis except for net operating loss and credit carryforwards. As of December 31, 2011 and 2010, income taxes due from SJI were approximately $1.0 million and $7.1 million, respectively, and are included in the balance sheets under the caption, Prepaid Taxes for the respective years.
As of December 31, 2011, SJG has total federal net operating loss carryforwards of $113.7 million and state net operating loss carryforwards of $30.0 million, both of which will expire in 2031. A valuation allowance is established when it is determined that it is more likely than not that a deferred tax asset will not be realized.
A reconciliation of unrecognized tax benefits is as follows (in thousands):
The total unrecognized tax benefits as of December 31, 2011 were $0.4 million, not including $0.6 million of accrued interest and penalties. The total unrecognized tax benefits as of December 31, 2010 were $0.5 million, not including $0.6 million of accrued interest and penalties. The total unrecognized tax benefits as of December 31, 2009 were $0.6 million, not including $0.5 million of accrued interest and penalties. The amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate is not significant. Our policy is to record interest and penalties related to unrecognized tax benefits as interest expense and other expense respectively. These amounts were not significant in 2011, 2010 or 2009. There have been no material changes to the unrecognized tax benefits during 2011, 2010 or 2009 and we do not anticipate any significant changes in the total unrecognized tax benefits within the next 12 months.
The unrecognized tax benefits are primarily related to an uncertainty of state income taxes. Federal income tax returns from 2008 forward, and state income tax returns primarily from 2007 forward, are open and subject to examination.
7.
LONG-TERM DEBT:
A schedule of our long-term debt as of December 31, including current maturities, is as follows (in thousands):
(A)
Long-term debt maturities and sinking funds requirements for the succeeding five years are as follows (in thousands): 2012, $2,187; 2013, $27,188; 2014, $23,187; 2015, $13,096; 2016, $30,097 (See Note (D) below). Our long-term debt agreements contain no financial covenants.
(B)
Our First Mortgage dated October 1, 1947, as supplemented, securing the First Mortgage Bonds constitutes a direct first mortgage lien on substantially all utility plant.
(C)
On July 15, 2011, SJG retired its 6.74% and 6.57% Medium Term Notes (MTN), at par.
(D)
These variable rate demand bonds bear interest at a floating rate that resets weekly. The interest rate as of December 31, 2011 was 0.12%. Liquidity support on these bonds was provided by a letter of credit from a commercial bank that would have expired in August 2011, and as such, these bonds were included in the current portion of long-term debt as of December 31, 2010. Liquidity support is now provided under a separate letter of credit facility that expires in August, 2015. Consequently, these bonds are now included in long-term debt as of December 31, 2011. These bonds contain no financial covenants.
(E)
See Note 16 - Subsequent Event.
During 2010, SJG issued $115.0 million aggregate principal amount of its Medium Term Notes in private placements due 2025, 2026 and 2027 and retired its $10.0 million, 6.12% Medium Term Notes at par. In 2011, SJG entered into an arrangement to issue Medium Term Notes under a private placement in an aggregate principal amount of $35.0 million. SJG expects to issue this debt in April 2012. Also in 2011, SJG repaid $25.0 million of First Mortgage Bonds. As of September 30, 2011 the $150.0 million Medium Term Note program that was approved by the BPU in September 2009 expired. In December 2011, SJG received approval from the BPU to issue up to $200.0 million in long-term debt under its MTN program by September 30, 2014.
We estimated the fair values of our long-term debt, including current maturities, as of December 31, 2011 and 2010, to be $472.0 million and $455.5 million, respectively. Carrying amounts as of both December 31, 2011 and 2010 are $365.0 million and $390.0 million, respectively. We base the estimates on interest rates available to us at the end of each year for debt with similar terms and maturities. We retire debt when it is cost effective as permitted by the debt agreements.
8.
FINANCIAL INSTRUMENTS:
Restricted Investments - In accordance with the terms of our tax-exempt first mortgage bonds, unused proceeds are required to be escrowed pending approved construction expenditures. As of both December 31, 2011 and 2010, the escrowed proceeds, including interest earned, totaled $0.1 million. Beginning in the third quarter of 2010, SJG established a margin account with SJRG in conjunction with SJG’s risk management activities as detailed in Notes 1 and 14. The funds provided by SJG will increase or decrease as the number and value of outstanding energy-related contracts held with SJRG changes. The balance held with SJRG totaled $2.1 million and $4.2 million as of December 31, 2011 and 2010, respectively.
Long-Term Receivables - SJG provides financing to customers for the purpose of attracting conversions to natural gas heating systems from competing fuel sources. The terms of these loans call for customers to make monthly payments over a period of up to five years with no interest. The carrying amounts of such loans were $11.7 million and $10.4 million as of December 31, 2011 and 2010, respectively. The current portion of these receivables is reflected in Accounts Receivable and the non-current portion is reflected in Long-Term Receivables on the balance sheet. The carrying amounts noted above are net of unamortized discounts resulting from imputed interest in the amount of $1.2 million as of both December 31, 2011 and 2010. The annual amortization to interest is not material to SJG’s financial statements. The carrying amounts of these receivables approximate their fair value at December 31, 2011 and 2010.
Other Financial Instruments - The carrying amounts of our other financial instruments approximate their fair values at December 31, 2011 and 2010.
9.
UNUSED LINES OF CREDIT:
Credit facilities and available liquidity as of December 31, 2011 were as follows (in thousands):
(A) A new revolving credit facility was established by SJG in May 2011. The SJG facility is a $200.0 million, four-year facility, provided by a syndicate of banks. The revolving credit facility contains one financial covenant limiting the ratio of indebtedness to total capitalization (as defined in the credit agreement) to not more than 0.65 to 1, measured at the end of each fiscal quarter. SJG was in compliance with this covenant as of December 31, 2011. This facility replaces SJG’s $100.0 million revolving credit facility and $40.0 million committed line of credit, both of which would otherwise have expired in August of 2011.
In July 2011, SJG began a commercial paper program under which SJG may issue short-term, unsecured promissory notes to qualified investors up to a maximum aggregate amount outstanding at any time of $200.0 million. The notes will have fixed maturities which will vary by note, but may not exceed 270 days from the date of issue. Proceeds from the notes will be used for general corporate purposes. SJG intends to use the commercial paper program in tandem with its new $200.0 million revolving credit facility and does not expect the principal amount of borrowings outstanding under the commercial paper program and the credit facility at any time to exceed an aggregate of $200.0 million.
Average borrowings outstanding under these credit facilities during the twelve months ended December 31, 2011 and 2010 were $71.6 million and $89.3 million, respectively. The maximum amount outstanding under these credit facilities during the twelve months ended December 31, 2011 and 2010 were $139.9 million and $130.9 million, respectively.
Based upon the existing credit facilities and a regular dialogue with our banks, we believe there will continue to be sufficient credit available to meet our future liquidity needs.
All committed facilities contain one financial covenant regarding the ratio of total debt to total capitalization, measured on a quarterly basis. SJG was in compliance with these covenants as of December 31, 2011. Borrowings under these credit facilities are at market rates. The weighted average borrowing cost, which changes daily, was 0.62%, 0.71% and 0.80% at December 31, 2011, 2010, and 2009, respectively.
10.
RETAINED EARNINGS:
Various loan agreements contain potential restrictions regarding the amount of cash dividends or other distributions that we may pay on our common stock. As of December 31, 2011, these loan restrictions did not affect the amount that may be distributed from our retained earnings.
We received no equity infusions from SJI in 2011, 2010 or 2009. Future equity contributions will occur on an as needed basis.
11.
PENSION AND OTHER POSTRETIREMENT BENEFITS:
We participate in the defined benefit pension plans and other postretirement benefit plans of SJI. The pension plans provide annuity payments to the majority of full-time, regular employees upon retirement. Participation in the SJI qualified defined benefit pension plans was closed to new employees beginning in 2003; however, employees who are not eligible for these pension plans are eligible to receive an enhanced version of SJI’s defined contribution plan. Certain officers of SJG also participate in the non-funded supplemental executive retirement plan (SERP) of SJI, a non-qualified defined benefit pension plan. The other postretirement benefit plans provide health care and life insurance benefits to some retirees.
Net periodic benefit cost related to the employee and officer pension and other postretirement benefit plans consisted of the following components (in thousands):
Capitalized benefit costs reflected in the table above relate to our construction program.
Companies with publicly traded equity securities that sponsor a postretirement benefit plan are required to fully recognize, as an asset or liability, the overfunded or underfunded status of its benefit plans and recognize changes in the funded status in the year in which the changes occur. Changes in funded status are generally reported in Other Comprehensive Loss; however, since we recover all prudently incurred pension and postretirement benefit costs from our ratepayers, a significant portion of the charges resulting from the recording of additional liabilities under this statement are reported as regulatory assets (See Note 4).
Details of the activity within the Regulatory Asset and Accumulated Other Comprehensive Loss associated with Pension and Other Postretirement Benefits are as follows (in thousands):
The estimated costs that will be amortized from Regulatory Assets into net periodic benefit costs in 2011 are as follows (in thousands):
The estimated costs that will be amortized from Accumulated Other Comprehensive Loss into net periodic benefit costs in 2011 are as follows (in thousands):
A reconciliation of the plans’ benefit obligations, fair value of plan assets, funded status and amounts recognized in our balance sheets follows (in thousands):
The projected benefit obligation (PBO) and accumulated benefit obligation (ABO) of our qualified employee pension plans were $128.8 million and $117.0 million, respectively, as of December 31, 2011, and $113.4 million and $103.2 million, respectively, as of December 31, 2010. The ABO of these plans exceeded the value of the plan assets as of December 31, 2011 and December 31, 2010. The value of these assets can be seen in the tables above. The PBO and ABO for our non-funded SERP were $31.5 million and $29.2 million, respectively, as of December 31, 2011, and $24.7 million and $24.3 million, respectively, as of December 31, 2010. The SERP is reflected in the tables above and has no assets.
The weighted-average assumptions used to determine benefit obligations at December 31 were:
The weighted-average assumptions used to determine net periodic benefit cost for years ended December 31 were:
All obligations disclosed herein reflect the use of the RP 2000 mortality tables.
The discount rates used to determine the benefit obligations at December 31, 2011 and 2010, which are used to determine the net periodic benefit cost for the subsequent year, were based on a portfolio model of high-quality instruments with maturities that match the expected benefit payments under our pension and other postretirement benefit plans.
The expected long-term return on plan assets (“return”) has been determined by applying long-term capital market projections provided by our pension plan Trustee to the asset allocation guidelines, as defined in the Company’s investment policy, to arrive at a weighted average return. For certain other equity securities held by an investment manager outside of the control of the Trustee, the return has been determined based on historic performance in combination with long-term expectations. The return for the other postretirement benefits plan is determined in the same manner as discussed above; however, the expected return is reduced based on the taxable nature of the underlying trusts.
The assumed health care cost trend rates at December 31 were:
Assumed health care cost trend rates have a significant effect on the amounts reported for our postretirement health care plans. A one-percentage-point change in assumed health care cost trend rates would have the following effects (in thousands):
PLAN ASSETS - The Company’s overall investment strategy for pension plan assets is to achieve a diversification by asset class, style of manager, and sector and industry limits to achieve investment results that match the actuarially assumed rate of return, while preserving the inflation adjusted value of the plans. The Company has implemented this diversification strategy primarily with commingled common/collective trust funds. The target allocations for pension plan assets are 35-46 percent U.S. equity securities, 12-18 percent international equity securities, 31-43 percent fixed income investments, and 2-17 percent to all other types of investments. Equity securities include investments in commingled common/collective trust funds as well as large-cap and mid-cap companies. Fixed income securities include commingled common/collective trust funds, group annuity contracts for pension payments, and hedge funds. Other types of investments include investments in private equity funds and real estate funds that follow several different strategies.
The strategy recognizes that risk and volatility are present to some degree with all types of investments. We seek to avoid high levels of risk at the total fund level through diversification by asset class, style of manager, and sector and industry limits. Specifically prohibited investments include, but are not limited to, venture capital, margin trading, commodities and securities of companies with less than $250.0 million capitalization (except in the small-cap portion of the fund where capitalization levels as low as $50.0 million are permissible). These restrictions are only applicable to individual investment managers with separately managed portfolios and do not apply to mutual funds or commingled trusts.
We evaluated its pension and other postretirement benefit plans’ asset portfolios for the existence of significant concentrations of credit risk as of December 31, 2011 Types of concentrations that were evaluated include, but are not limited to, investment concentrations in a single entity, type of industry, foreign country, and individual fund. As of December 31, 2011, there were no significant concentrations (defined as greater than 10 percent of plan assets) of risk in SJI’s pension and other postretirement benefit plan assets.
GAAP establishes a hierarchy that prioritizes fair value measurements based on the types of inputs used for the various valuation techniques. This hierarchy groups assets into three (3) distinct levels as fully described in Note 13, that will serve as the basis for presentation throughout the remainder of this Note.
The fair values of SJG’s pension plan assets at December 31, 2011 and 2010 by asset category are as follows (in thousands):
(a)
This category represents common/collective trust fund investments through a commingled employee benefit trust (excluding real estate). These commingled funds are not traded publicly; however, the majority of the underlying assets held in these funds are stocks and bonds that are traded on active markets and prices for these assets are readily observable. Also included in these funds are interest rate swaps, asset backed securities, mortgage backed securities and other investments with observable market values. Holdings in these commingled funds are classified as Level 2 investments.
(b)
This category represents short-term investment funds held for the purpose of funding disbursement payment arrangements. Underlying assets are based on quoted prices in active markets, or where quoted prices are not available, based on models using observable market information. Since not all values can be obtained from quoted prices in active markets, these funds are classified as Level 2 investments.
(c)
This category of equity investments represents a managed portfolio of common stock investments in five sectors: telecommunications, electric utilities, gas utilities, water and energy. These common stocks are actively traded on exchanges and price quotes for these shares are readily available. These common stocks are classified as Level 1 investments.
(d)
This category represents SJI’s Group Annuity contracts with a nationally recognized life insurance company. The contracts are the assets of the plan, while the underlying assets of the contracts are owned by the contract holder. Valuation is based on a formula and calculation specified within the contract. Since the valuation is based on the reporting entity’s own assumptions, these contracts are classified as Level 3 investments.
(e)
This category represents a collection of underlying funds which are all domiciled outside of the United States. Most of the underlying fund managers are based in the U.S.; however, they do not necessarily trade only in U.S. markets. It is important to note that the SJI Pension Funds completed the divestiture of investments from this fund of funds during 2011. The fair value of these funds is determined by the underlying fund’s general partner or manager. These funds are classified as Level 3 investments.
(f)
This category represents a limited partnership which includes several investments in U.S. leveraged buyout, venture capital, and special situation funds. Fund valuations are reported on a 90 day lag and, therefore, the value reported herein represents the market value as of September 30, 2011 and 2010, respectively. The fund’s investments are stated at fair value, which is generally based on the valuations provided by the general partners or managers of such investments. Fund investments are illiquid and resale is restricted. These funds are classified as Level 3 investments.
(g)
This category represents real estate common/collective trust fund investments through a commingled employee benefit trust. These commingled funds are part of a direct investment in a pool of real estate properties. These funds are valued by investment managers on a periodic basis using pricing models that use independent appraisals from sources with professional qualifications. Since these valuation inputs are not highly observable, the real estate funds are classified as Level 3 investments.
Fair Value Measurement Using Significant
Unobservable Inputs (Level 3)
(In thousands)
As with the pension plan assets, the Company’s overall investment strategy for post-retirement benefit plan assets is to achieve a diversification by asset class, style of manager, and sector and industry limits to achieve investment results that match the actuarially assumed rate of return, while preserving the inflation adjusted value of the plans. The Company has implemented this diversification strategy with a mix of common/collective trust funds and mutual funds. The target allocations for post-retirement benefit plan assets are 38 percent U.S. equity securities, 25 percent international equity securities, and 37 percent fixed income investments. Equity securities include investments in large-cap, mid-cap and small-cap companies. Fixed income securities within the common/collective trust fund include primarily investment grade, U.S. Government and mortgage-backed financial instruments.
The fair values of SJG’s other postretirement benefit plan assets at December 31, 2011 and 2010 by asset category are as follows (in thousands):
(a)
This category represents common/collective trust fund investments through a commingled employee benefit trust (excluding real estate). These commingled funds are not traded publicly; however, the majority of the underlying assets held in these funds are stocks and bonds that are traded on active markets and prices for these assets are readily observable. Also included in these funds are interest rate swaps, asset backed securities, mortgage backed securities and other investments with observable market values. Holdings in these commingled funds are classified as Level 2 investments.
(b)
This category represents mutual fund investments. The mutual funds are actively traded on exchanges and price quotes for the shares are readily available. These mutual funds are classified as Level 1 investments.
Future Benefit Payments - The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid during the following years (in thousands):
Contributions - We made no contributions to our qualified employee pension plans in 2011; however, $19.8 million was contributed to the plans in January, 2012. Payments related to the unfunded SERP plan are expected to approximate $1.2 million in 2012. We also have a regulatory obligation to contribute approximately $3.6 million annually to our other postretirement benefit plans’ trusts, less costs incurred directly by us.
Defined Contribution Plan - We also offer an Employees’ Retirement Savings Plan (Savings Plan) to eligible employees. For employees eligible for participation in SJI's defined benefit pension plans, SJG matches 50% of participants’ contributions up to 6% of base compensation. For employees who are not eligible for participation in SJI’s defined benefit plans, we match 50% of participants’ contributions up to 8% of base compensation. Employees not eligible for the pension plans also receive a year-end contribution of $1,000 if 10 or fewer years of service, or $1,500 if more than 10 years of service. The amount expensed and contributed for the matching provision of the Savings Plan approximated $0.8 million, $0.8 million and $0.7 million for the years ended December 31, 2011 and 2010, and 2009, respectively.
12.
COMMITMENTS AND CONTINGENCIES:
Standby Letter Of Credit - SJG provided a $25.2 million letter of credit, under a separate credit facility from those it borrows under to provide liquidity support for the remarketing of variable-rate demand bonds issued through the NJEDA. The bonds were used to finance the expansion of SJG’s natural gas distribution system as discussed in Note 7. This letter of credit expires in August 2015.
Gas Supply Related Contracts - In the normal course of conducting business, we have entered into long-term contracts for natural gas supplies, firm transportation and gas storage service. The earliest that any of these contracts expires is October 2012. The transportation and storage service agreements between us and our interstate pipeline suppliers were made under FERC approved tariffs. Our cumulative obligation for demand charges and reservation fees paid to suppliers for these services averages approximately $3.7 million per month and is recovered on a current basis through the BGSS.
Pending Litigation - We are subject to claims arising in the ordinary course of business and other legal proceedings. We accrue liabilities related to these claims when we can reasonably estimate the amount or range of amounts of probable settlement costs or other charges for these claims. The Company has accrued approximately $0.2 million and $1.4 million related to all claims in the aggregate, as of December 31, 2011 and 2010, respectively. Management does not believe that it is reasonably possible that there would be a material change in the Company's estimated liability in the near term and does not currently anticipate the disposition of any known claims to have a material effect on our financial position, results of operations or liquidity.
Collective Bargaining Agreements - Unionized personnel represent approximately 63% of our workforce at December 31, 2011. The Company has collective bargaining agreements with two unions who represent these employees: the International Brotherhood of Electrical Workers (IBEW) that operates under a collective bargaining agreement that runs through February 2013, with the option to extend until February 2014 at the union's election, and the International Association of Machinists and Aerospace Workers (IAM) that operates under a collective bargaining agreement that runs through August 2014.
Environmental Remediation Costs - We incurred and recorded costs for environmental cleanup of 12 sites where we or our predecessors operated gas manufacturing plants. We stopped manufacturing gas in the 1950s.
We successfully entered into settlements with all of our historic comprehensive general liability carriers regarding the environmental remediation expenditures at our sites. Also, we have purchased a Cleanup Cost Cap Insurance Policy limiting the amount of remediation expenditures that we will be required to make at 11 of our sites. This policy will be in force until 2024 at 10 sites and until 2029 at one site. The future cost estimates discussed hereafter are not reduced by projected insurance recoveries from the Cleanup Cost Cap Insurance Policy. The policy is limited to an aggregate payment amount of $50.0 million, of which we have recovered $47.2 million through December 31, 2011. As discussed in Note 3, the BPU allows SJG to recover environmental remediation costs through the RAC.
Since the early 1980s, we accrued environmental remediation costs of $276.2 million, of which $186.2 million has been spent as of December 31, 2011. The following table details the amounts accrued and expended for environmental remediation at December 31 (in thousands):
The balances are segregated between current and noncurrent on the balance sheets under the captions Current Liabilities and Regulatory and Other Noncurrent Liabilities.
Management estimates that undiscounted future costs to clean up our sites will range from $90.0 million to $217.2 million. We recorded the lower end of this range, $90.0 million, as a liability because a single reliable estimation point is not feasible due to the amount of uncertainty involved in the nature of projected remediation efforts and the long period over which remediation efforts will continue. Six of our sites comprise the majority of these estimates, ranging from a low of $70.8 million to a high of $171.0 million. Recorded amounts include estimated costs based on projected investigation and remediation work plans using existing technologies. Actual costs could differ from the estimates due to the long-term nature of the projects, changing technology, government regulations and site-specific requirements. Significant risks surrounding these estimates include unforeseen market price increases for remedial services, property owner acceptance of remedy selection, regulatory approval of selected remedy and remedial investigative findings.
The remediation efforts at our six most significant sites include the following:
Site 1 - Remediation of the site is currently underway in accordance with the remedial action work plan approved by the New Jersey Department of Environmental Protection (NJDEP). Remaining steps to complete the remedy include continued excavation of impacted soil and groundwater monitoring and sampling.
Site 2 - Various remedial investigation and action activities are ongoing at this site. An interim remedial measure has been implemented and a remedial action work plan has been prepared and submitted to the NJDEP for an offsite, interim remedial measure. Remaining steps to remediate soil and groundwater include completing the remedial investigation of impacted soil and groundwater in preparation for selecting the appropriate action and implementation and gaining regulatory and property owner approval of the selected remedy.
Site 3 - Various remedial investigation and action activities are ongoing at this site. Remaining steps include completion of an interim remedial action at one off site property and final remedy selection for the remaining impacts at the site, regulatory approval of the final remedy, and implementation of the selected remedy to address remaining impacted soil and groundwater.
Site 4 - Remedial investigation activities are ongoing at this site including pilot studies of potential remedial alternatives and continued soil and groundwater investigation. Remaining steps to remediate the site include completing the investigation of impacted soil and groundwater in preparation for selecting the appropriate action, gaining regulatory and property owner approval of the selected remedy and implementation of the remedy once approved.
Site 5 - Remedial investigation activities are ongoing at this site. Remaining steps include completing the remedial investigation of impacted soil and groundwater in preparation for selecting the appropriate action and implementation and gaining regulatory and property owner approval of the selected remedy.
Site 6 - Remedial investigation activities are ongoing at this site. Remaining steps to remediate include completing the remedial investigation of impacted soil and groundwater in preparation for selecting the appropriate action and implementation and gaining regulatory approval of the selected remedy.
13.
FAIR VALUE OF FINANCIAL ASSETS AND FINANCIAL LIABILITIES:
GAAP establishes a hierarchy that prioritizes fair value measurements based on the types of inputs used for the various valuation techniques. The levels of the hierarchy are described below:
•Level 1: Observable inputs such as quoted prices in active markets for identical assets or liabilities.
•Level 2: Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly; these include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active.
•Level 3: Unobservable inputs that reflect the reporting entity’s own assumptions.
Assessment of the significance of a particular input to the fair value measurement requires judgment and may affect the valuation of financial assets and financial liabilities and their placement within the fair value hierarchy.
For financial assets and financial liabilities measured at fair value on a recurring basis, information about the fair value measurements for each major category is as follows (in thousands):
(A) Available-for-Sale Securities include securities that are traded in active markets and securities that are not traded publicly. The securities were traded in active markets as of December 31, 2010 and valued using the quoted principal market close prices that were provided provided by the trustees and were categorized in Level1 in the fair value hierarchy. During the first quarter of 2011, the securities were sold and reinvested in funds that reduced the Company's fees. As of December 31, 2011, these funds, which consist of stocks and bonds that are traded individually in active markets, are valued using quoted prices for similar assets and categorized in Level 2 in the fair value hierarchy.
(B) Derivatives - Energy Related Assets and Liabilities are traded in both exchange-based and non-exchange-based markets. Exchange-based contracts are valued using unadjusted quoted market sources in active markets and are categorized in Level 1 in the fair value hierarchy. Certain non-exchange-based contracts are valued using indicative price quotations available through brokers or over-the-counter, on-line exchanges and, are categorized in Level 2. These price quotations reflect the average of the bid-ask mid-point prices and are obtained from sources that management believes provide the most liquid market. Management reviews and corroborates the price quotations to ensure the prices are observable which includes consideration of actual transaction volumes, market delivery points, bid-ask spreads and contract duration.
(C) Derivatives - Other, include interest rate swaps that are valued using quoted prices on commonly quoted intervals, which are interpolated for periods different than the quoted intervals, as inputs to a market valuation model. Market inputs can generally be verified and model selection does not involve significant management judgment.
14.
DERIVATIVE INSTRUMENTS:
SJG is involved in buying, selling, transporting and storing natural gas and is subject to market risk on expected future purchases and sales due to commodity price fluctuations. The Company, through its affiliate South Jersey Resources Group (SJRG), uses a variety of derivative instruments to limit this exposure to market risk in accordance with strict corporate guidelines. These derivative instruments include forward contracts, futures contracts, swap agreements and options contracts.
As of December 31, 2011, SJG had outstanding derivative contracts intended to limit the exposure to market risk on 10.1 MMdts of expected future purchases of natural gas. These contracts, which do not qualify for the normal purchase and sale exemption and have not been designated as hedging instruments under GAAP, are measured at fair value and recorded in Derivatives - Energy Related Assets or Derivatives - Energy Related Liabilities on the balance sheets. The costs or benefits of these short-term contracts are recoverable through SJG’s Basic Gas Supply Service (BGSS) clause, subject to BPU approval. As a result, the net unrealized pre-tax gains and losses for these energy related commodity contracts are included with realized gains and losses in Regulatory Assets or Regulatory Liabilities on the balance sheets. As of December 31, 2011 and 2010, SJG had $10.2 million and $5.0 million of unrealized losses, respectively, included in its BGSS related to open financial contracts.
The Company has also entered into interest rate derivatives to hedge exposure to increasing interest rates and the impact of those rates on cash flows of variable-rate debt. These interest rate derivatives, which have not been designated as hedging instruments under GAAP, are measured at fair value and recorded in Derivatives-Other on the balance sheets. The fair value represents the amount SJG would have to pay the counterparty to terminate these contracts as of those dates. Subject to BPU approval, the market value upon termination of these interest rate derivatives can be recovered in rates and therefore these unrealized losses have been included in Regulatory Assets on the balance sheets.
We previously used derivative transactions known as “Treasury Locks” to hedge against the impact on our cash flows of possible interest rate increases on debt issued in September 2005. The initial $1.4 million cost of the Treasury Locks has been included in Accumulated Other Comprehensive Loss and is being amortized over the 30 year life of the associated debt issue. As of December 31, 2011, the unamortized balance is approximately $1.1 million.
As of December 31, 2011, SJG’s active interest rate swaps were as follows:
The fair values of all derivative instruments, as reflected in the balance sheets as of December 31, 2011 and 2010 are as follows (in thousands):
The effect of derivative instruments on the statements of income for 2011, 2010 and 2009 are as follows (in thousands):
(a) Included in Interest Charges
Net realized losses associated with SJG’s energy related financial commodity contracts of $12.9 million , $23.5 million and $51.9 million for 2011, 2010 and 2009, respectively, are not included in the above table. These contracts are part of SJG’s regulated risk management activities that serve to mitigate BGSS costs passed on to its customers. As these transactions are entered into pursuant to, and recoverable through, regulatory riders, any changes in the value of SJG’s energy-related financial commodity contracts are deferred in Regulatory Assets or Liabilities and there is no impact to earnings.
15.
QUARTERLY RESULTS OF OPERATIONS - UNAUDITED:
The summarized quarterly results of our operations are as follows (in thousands):
NOTE: Because of the seasonal nature of our business, statements for the 3-month periods are not indicative of the results for a full year.
16.
SUBSEQUENT EVENT:
In February 2012, SJG called its $35.0 million, 7.7% MTN's due April 2027 at par plus a 2% premium. The early redemption will occur concurrently with the issuance of $35.0 million, 3.74% MTN's in April 2012, as discussed in Note 7.
Item 9.
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
The Company’s management, with the participation of its chief executive officer and chief financial officer, evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of December 31, 2011. Based on that evaluation, the Company’s chief executive officer and chief financial officer concluded that the disclosure controls and procedures employed at the Company are effective.
Management’s Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined under Exchange Act Rules 13a-15(f). The Company’s internal control system is designed to provide reasonable assurance to its management and board of directors regarding the preparation and fair presentation of published financial statements. Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under that framework, management concluded that our internal control over financial reporting was effective as of December 31, 2011.
This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. The Company's internal control over financial reporting was not subject to attestation by the Company’s registered public accounting firm pursuant to rules issued by the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.
Changes in Internal Control over Financial Reporting
There has not been any change in the Company's internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act, during the fiscal quarter ended December 31, 2011 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
Item 9B.
Item 9B. Other Information
None.
Part III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
Omitted in accordance with General Instruction I 1(a) and (b) of Form 10-K.
Item 11.
Item 11. Executive Compensation
Omitted in accordance with General Instruction I 1(a) and (b) of Form 10-K.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters
Omitted in accordance with General Instruction I 1(a) and (b) of Form 10-K.
Item 13.
Item 13. Certain Relationships and Related Transactions,
and Director Independence
Omitted in accordance with General Instruction I 1(a) and (b) of Form 10-K.
Item 14.
Item 14. Principal Accountant Fees and Services
Fees Paid to Auditors
Deloitte & Touche LLP served as the auditors of SJG and its parent, SJI, during 2011. In accordance with its charter, the Audit Committee pre-approved all services provided by Deloitte & Touche LLP. Audit services performed consisted of the audits of the financial statements and the preparation of various reports based on those audits and services related to filings with the United States Securities and Exchange Commission and New York Stock Exchange.
Audit Fees
The aggregate fees billed for the audit of SJG’s financial statements by Deloitte & Touche LLP totaled $410 thousand and $385 thousand in fiscal years 2011 and 2010, respectively.
Audit-Related Fees
None.
Tax Fees
None.
All Other Fees
None.
Part IV
Item 15.
Item 15. Exhibits and Financial Statement Schedule
(a)
Listed below are all financial statements and schedules filed as part of this report:
1 - The financial statements and notes to financial statements together with the report thereon of Deloitte & Touche LLP, February 28, 2012, are file as part of this report under Item 8 - Financial Statements and Supplementary Data.
2 - Supplementary Financial Information
Schedule II - Valuation and Qualifying Accounts. See page 67.
All schedules, other than that listed above, are omitted because the information called for is included in the financial statements filed or because they are not applicable or are not required.
(b)
List of Exhibits (Exhibit Number is in Accordance with the Exhibit Table in Item 601 of Regulation S-K).
* Constitutes a management contract or a compensatory plan or arrangement.
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.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
SOUTH JERSEY GAS COMPANY
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
(In Thousands)
(a) Recoveries of accounts previously written off and minor adjustments.
(b) Uncollectible accounts written off.