Business Context and Reporting Period
Company: New Jersey Resources Corporation (NJR)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: December 31, 2008
Business Overview: NJR is an energy services holding company operating through two primary subsidiaries: New Jersey Natural Gas Company (NJNG), a regulated utility providing retail natural gas service in New Jersey, and NJR Energy Services Company (NJRES), an unregulated wholesale energy marketer. The company also holds investments in energy-related ventures, including a 5.53% interest in the Iroquois Gas Transmission System and a 50% interest in the Steckman Ridge natural gas storage facility.
Key Financial Metrics
| Metric (in thousands, except per share) | Q4 2008 | Q4 2007 |
|---|---|---|
| Operating Revenues | $801,304 | $811,138 |
| Operating Expenses | $779,108 | $756,601 |
| Operating Income | $22,196 | $54,537 |
| Net Income | $11,776 | $30,185 |
| Earnings Per Share (Diluted) | $0.28 | $0.72 |
| Dividends Per Share | $0.31 | $0.27 |
| Cash Flow from Operating Activities | ($36,960) | ($6,525) |
| Cash Flow from Investing Activities | ($36,614) | ($17,900) |
| Cash Flow from Financing Activities | $56,911 | $23,130 |
| Total Assets | $2,687,387 | $2,625,392 |
| Long-Term Debt | $460,708 | $455,117 |
| Short-Term Debt | $265,550 | $178,200 |
Material Changes vs. Prior Period
- Net Income Decline: Net income decreased 61% to $11.8 million from $30.2 million in the prior year. This was primarily driven by a significant loss in the Energy Services segment due to realized losses on derivatives hedging natural gas inventory, caused by declining NYMEX prices.
- Segment Performance:
- Natural Gas Distribution (NJNG): Operating income increased 33.5% to $42.2 million, driven by higher utility gross margins from base rate increases approved in October 2008 and colder weather (10% colder than the prior year).
- Energy Services (NJRES): Reported an operating loss of $9.4 million compared to income of $22.6 million in the prior year. The decline was due to a $16.6 million net-of-tax realized loss on derivatives and the expiration of a favorable physical transport capacity contract.
- Retail and Other: Reported a net loss of $5.7 million, largely due to unrealized losses on financial derivatives held by NJR Energy.
- Working Capital: Cash used in operating activities increased significantly to $37.0 million (from $6.5 million used in the prior year), reflecting lower net income and changes in working capital components such as receivables and gas inventory values.
Guidance, Outlook, Risks, and Unusual Items
- Regulatory Developments: The New Jersey Board of Public Utilities (BPU) approved a base rate increase for NJNG effective October 3, 2008, providing a $32.5 million revenue increase and a 10.3% return on equity. NJNG also implemented a $30 million BGSS rate credit for customers in January and February 2009 due to declining wholesale costs.
- Derivative Accounting: Effective October 1, 2008, NJRES changed its accounting treatment for physical commodity contracts, recording them at fair value rather than using the "normal purchase normal sales" exception. This change, combined with market volatility, contributed to significant earnings volatility.
- Capital Projects: NJR continues development of the Steckman Ridge storage facility, with total project costs estimated at $265 million. NJR is obligated to fund 50% ($132.5 million). The facility is expected to be in service in summer 2009.
- Internal Control Weakness: The company disclosed a material weakness in internal controls over financial reporting related to the recording of physical natural gas transactions at incorrect fair values in prior interim periods. Remediation efforts are underway, but the weakness was not fully remediated as of December 31, 2008.
- Market Risks:
- Commodity Prices: Significant exposure to natural gas price volatility. NJRES uses derivatives to hedge, but mismatches in timing between derivative settlements and physical sales create earnings volatility.
- Credit Markets: Failure of Auction Rate Securities (ARS) auctions for NJNG's variable-rate debt resulted in interest rates resetting to maximum levels (10-12%), though the weighted average rate remained low (0.8%) due to low LIBOR. Continued volatility in credit markets poses a risk to liquidity and financing costs.
Investor Verification Checklist
- Derivative Exposure: Verify the extent of unrealized and realized losses on derivatives and the company's ability to manage cash flow volatility in the Energy Services segment.
- Internal Controls: Monitor the progress of remediation for the material weakness in internal controls regarding commodity transaction accounting.
- Regulatory Recovery: Confirm the status of regulatory asset recoveries, particularly for Manufactured Gas Plant (MGP) remediation costs ($120.2 million liability recorded) and the Conservation Incentive Program (CIP).
- Debt Covenants: Review compliance with debt covenants, specifically the maximum leverage ratio (0.65 to 1.00) and interest coverage ratios, given the increase in short-term debt.
- Steckman Ridge Financing: Assess the likelihood of securing non-recourse project financing for the Steckman Ridge facility to reduce NJR's recourse obligation.