CORNING NATURAL GAS CORP – 10-K – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Management's Discussion and Analysis of Financial Condition and Results of Operations

Overview

Our primary business is natural gas distribution. We serve approximately 14,700 customers through 400 miles of pipeline in the Corning, Hammondsport and Virgil, New York areas. The market for natural gas in our traditional service territory is relatively saturated with limited growth potential. However, growth opportunities do exist in extending our mains to areas adjacent or reasonably close to areas we currently serve. In addition, the Company continues to see expansion opportunities in the commercial and industrial markets. Two of our largest customers, Corning Incorporated and World Kitchen, added additional manufacturing capacity in our service area that is increasing our revenue and margins. We believe that our most promising growth opportunity for both revenues and margins is increasing connection with local gas production sources. We completed a new pipeline to Marcellus Shale gas in Pennsylvania in 2009 and we believe that pipeline could, depending on the volume of gas extracted and directed through the pipeline by the producer, significantly increase throughput on our system and have a significant impact on margins. In 2010 we upgraded portions of Lines 4, 7 and 13 to increase our capacity to transport local production gas. We have completed a compressor station that is working in conjunction with our pipeline upgrades to transport gas on our system and into the interstate pipeline system. In addition, we have formed a joint venture, Leatherstocking Gas Company, LLC, to pipe gas to areas of the northeast currently without gas service. We continue to focus on improving the efficiency of our operations and making capital investments to improve our infrastructure.

Our key performance indicators are net income and shareholders' equity.

                                                       Year Ended September 30,                                                    2011        2010        2009 Net income                                       $1,348,828  $1,641,623   $672,285 Shareholders' equity                            $14,646,582 $13,676,797 $9,396,862 

Shareholders' equity per weighted average share $8.39$8.75$7.34

In 2011, our consolidated net income was $1.3 million, a decrease of $292,795 from 2011 mainly because of an increase in property taxes and depreciation and unfavorable regulatory reconciliations.

In 2010, our consolidated net income was $1.6 million. Net income in 2010 was higher than 2009 mainly because of a full year under the rate increase that went into effect in September 2009, favorable Gas Adjustment Clause ("GAC") adjustments, the addition of large new customers and increased volumes used by existing major customers.

As a regulated utility company, shareholders' equity is an important performance indicator for us. The NYPSC allows us to earn a reasonable return on shareholders' equity. Shareholders' equity is therefore a precursor of future earnings potential. In 2011, shareholders' equity increased by $1 million due to exercise of stock options and warrants, raising $673,140. The equity per weighted average share ratio decreased for the period mainly due to the number of new shares issued with the stock dividend (see Note (k) Dividends). In 2010, shareholders' equity increased by $4.3 million due to a rights offering of our common stock, that raised $1.9 million in gross proceeds, favorable pension adjustments and positive earnings. In 2009, shareholders' equity increased by $1.8 million due to warrant holders exercising their rights and purchasing $2.8 million of common stock. Going forward, we continue to focus on rebuilding shareholders' equity.

Other performance indicators that we track include leak repair, main and service replacements and customer service metrics. In 2011 we invested $3.7 million in system improvements and projects, repairing 216 leaks, and replacing 314 services and 4 miles of main. Because of weather related issues, some major projects started late in the fiscal year and will continue for the remainder of calendar 2011. During 2010 we invested $4.5 million in system improvements and projects, repairing 139 leaks, and replacing 358 services and 6.5 miles of gas main. In 2009 we invested $4.8 million in system improvements and projects, repairing 190 leaks, and replacing 459 services and 10.6 miles of gas main.

Our customer service group has implemented several changes to positively impact our customers. Beginning in 2007, customers have the option of third party payment of their gas bill through their lending institution. We have also instituted online meter reading. Bill processing has been consolidated to shorten the time between meter readings and mailing, allowing a more direct link between the consumption of gas and the receipt by the customer of their bill. Our principal customer service metric is the number of customer complaints we receive. In 2011, the NYPSC reported 17 complaints against us. This compares to 20 in 2010 and 31 in 2009.

Earnings

Earnings on a consolidated basis were as follows:

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Net income

                            2011       2010      2009 

Consolidated net income $1,348,828$1,641,623$672,285

2011 compared with 2010. We had a decrease in net income of $292,795 to $1.3 million or $.77 per share, mainly due to increased property taxes, depreciation and unfavorable regulatory reconciliations.

2010 compared with 2009. We had an increase in net income of $969,338 to $1.6 million or $1.58 per share, from $672,285 or $0.79 per share because of a rate increase that went into effect in September 2009, favorable Gas Adjustment Clause ("GAC") adjustments, the addition of large new customers and increased volumes used by existing major customers.

Utility Operating Revenue

                                 2011        2010        2009 Retail Revenue: Residential               $12,509,662 $12,346,062 $13,274,447 Commercial                  2,016,216   1,950,471   2,440,722 Industrial                     59,733      59,732      76,612 Transportation              4,834,909   4,818,177   3,971,539 Total Retail Revenue       19,420,520  19,174,442  19,763,320  Wholesale                   2,206,017   2,321,203   3,093,361 Local Production            1,055,565     231,615     367,753 Other                         145,760     718,040     472,597 Total Revenue             $22,827,862 $22,445,300 $23,697,031  

The following tables further summarize other income on the operating revenue table:

                                                    2011     2010     2009 Other gas revenues: Customer discounts forfeited                   $92,757  $96,553 $115,467 Reconnect fees                                   3,620    3,720    5,020 Gas revenues subject to refund                  37,505  604,850  338,197 Surcharges                                      11,878   12,917   13,913 Total other gas revenues                      $145,760 $718,040 $472,597                                                    2011     2010     2009 Gas revenues subject to refund: Rate case amortizations                        $20,363  $20,363   $1,697 DRA carrying costs                              17,019   15,845  315,924 Estimated second stage rate increase accrual   216,604   20,090        - Monthly RDM amortizations                    (111,282)  162,707   20,576 Capacity Release Income                         51,690        -        - Annual RDM reconciliation                    (156,889)        -        - LAUF incentive benefit                               -  385,845        -                                                $37,505 $604,850 $338,197  </pre>
2011 compared with 2010. In 2011 our operating revenue increased $382,562, or 1.7%, primarily because of increased usage, local production revenues due to recognizing the revenue associated with offsetting our pipeline costs instead of offsetting plant (see Note (f) Depreciation) and the estimated second stage rate increase accrual that partially offset unfavorable regulatory amortizations and reconciliations.
2010 compared with 2009. In 2010 our operating revenue decreased $1.25 million, or 5.3%, primarily because of lower gas costs partially offset by the rate increase that went into effect in September 2009.
Margin
                                    2011        2010        2009  Utility Operating Revenues $22,827,862$22,445,300$23,697,031 Natural Gas Purchased        9,714,941   9,647,495  13,034,734 Margin                      13,112,921  12,797,805  10,662,297                                 57.44%      57.02%      44.99%  
Our margin (the excess of utility operating revenues over the cost of natural gas purchased) increased $315,116 from 2010 to 2011 mainly due to increased usage, increased production revenues and accrual for the second stage rate increase granted as part of our last rate case partially offsetting unfavorable regulatory reconciliations.
Our margin increased $2.1 million from 2009 to 2010 primarily because of the rate increase in effect from September 2009 as well as higher throughput. The margin percentage increased 12.03% for the same reasons.
Looking forward, we anticipate additional margin growth due to our latest rate increase request effective in 2012. Our cost of gas should remain stable because of our access to local production and a favorable gas supply asset management agreement that we entered into with ConocoPhillips in 2011.
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Operating Expenses
2011 compared with 2010. Operating expenses increased to $7.2 million in 2011 from $6.9 million in 2010 mainly due to increased property taxes and increased pension expense as determined in our 2009 rate order. Depreciation and amortization increased by $765,887 from 2010 to 2011 because we are now recognizing the revenue associated with offsetting our pipeline costs and increasing accumulated depreciation and depreciation expense instead of offsetting plant (see Note (f) Depreciation). There has been a slight increase in purchase gas costs of $67,446 due to higher volumes purchased at a lower average price.
2010 compared with 2009. Operating expenses increased to $6.9 million in 2010 from $6.6 million in 2009 primarily because of increased administrative expense associated with pension costs. These pension costs were determined in our 2009 rate order. Depreciation and amortization decreased from $762,197 in 2009 to $713,066 in 2010 because of monthly amortization of excess depreciation based on the Company's last depreciation study per our last rate order. Our purchase gas costs have decreased $3.4 million from 2010 to 2009 mainly because of lower gas prices.
Investment Income
2011 compared with 2010. Investment income increased by $60,901 to $181,542 in 2011 due to realized gains and dividend and interest income.
2010 compared with 2009. Investment income increased by $170,080 to a gain of $120,641 in 2010 from a loss of ($49,439) in 2009. This increase is the result of realized gains for the entire period as well as dividend and interest income.
Effective Tax Rate
Our effective tax rate for the period ending September 30, 2011 was 14.6% instead of the expected rate of 41.1% (34% federal provision and 7.1% New York State provision) due mainly to bonus depreciation on the Compressor Station, an asset not on the Company's Balance Sheet due to regulatory accounting (see Note (q) 311 Transportation Agreement/Compressor Station for more information). Our effective tax rate for the period ending September 30, 2010 was 37.2% instead of the expected rate of 41.1% (34% federal provision and 7.1% New York State provision) due to bonus depreciation and the adjustment back to a 34% federal provision for the prior fiscal year. Our effective tax rate for the period ending September 30, 2009 was 24.2% instead of the expected 42.1% (we were recognizing a 35% federal provision and 7.1% New York State provision) primarily due to bonus depreciation allowed this year. Taxes paid have also been affected by the amount of net operating loss (NOL) carryforward on both federal and state returns and have positively affected our effective tax rates. See also Note 6 to the Notes to Consolidated Financial Statements below.
Liquidity and Capital Resources
Internally generated cash from operating activities consists of net income, adjusted for non-cash expenses and changes in operating assets and liabilities. Non-cash items include depreciation and amortization, gain or loss on sale of securities and deferred income taxes. Over or under recovered gas costs significantly impact cash flow. In addition, there are significant year-to-year changes in regulatory assets that impact cash flow. Cash flows from investing activities consist primarily of capital expenditures.
In October 2008, we obtained $1 million of financing in a form of Demand Note from M&T Bank to help with the cost of our new construction. Interest on this loan is payable on the monthly basis at the rate equal to 1% above the prime rate. The initial interest rate on this loan was 5.5% and was 4.25% at the end of September 2010. The Company repaid $500,000 in December 2009 and repaid the balance in December 2010.
In September 2010, we entered into an agreement with Five Star Bank to provide $750,000 to fund construction of an upgrade to existing natural gas piping to serve increased gas demands on one of our main supply lines, including at three Corning Incorporated plants. Interest is payable monthly at a fixed rate of 4.25% per annum and unless sooner accelerated or demanded, the note matured on September 25, 2011. This note was refinanced with Five Star Bank on September 1, 2011 with the same terms. The new maturity date is August 31, 2012 unless accelerated or demanded sooner.
In July 2010, the $1.9 million Community Bank Term Loan was repaid in full. On May 7, 2008, we entered into a credit agreement with M&T Bank to provide for a $6.0 million loan for the purpose of retiring a $3.1 million first mortgage and an unsecured senior note in the amount of $1.5 million. The remaining proceeds were used to fund construction projects related to furnishing natural gas within the Company's service area. This loan was converted to a long term loan on October 16, 2008, with an interest rate of 5.96%. Great West Life & Annuity Insurance Company, the holder of the Company's $4.7 million 7.9% Senior Notes dated as of September 1, 1997, expressed its belief that the refinancing with M&T Bank breached the negative covenants contained in the 1997 note agreement. An Intercreditor and Collateral Agency Agreement went into effect on December 1, 2009 between Great West and M&T Bank, as well as amendments to September 1997 Notes, resolving this issue and providing the Company more flexibility relative to future borrowings. On March 4, 2010, the $6 million loan agreement with M&T Bank was amended with the principal change being an increase in the interest rate to 6.5%.
On May 7, 2010, the Company entered into a credit agreement with Community Bank N.A. for a $1.05 million promissory note at a fixed interest rate of 6.25% for the purpose of paying for the construction projects of our new franchise located in the town of Virgil. This agreement gives our lender security interest in all fixtures, equipment and inventory related to the Company's franchise in the town of Virgil as well as the Rabbi Trust account. The note also required an equity contribution of $350,000 which was accomplished by the exercise of 24,000 stock options by Michael I. German, President and CEO, at $15.00 per share or $360,000. The agreement included the following covenants to be measured at each fiscal year end starting with the September 30, 2009 financial statement: (i) maintain a tangible net worth of not less than $11.0 million, (ii) maintain a debt to tangible net worth of less than 3.0 to 1.0, and (iii) maintain a debt service coverage ratio of 1.10 to 1.
On October 27, 2010, the Company entered into a Multiple Disbursement Term Note with Manufacturers and Traders Trust Company in the amount of $1,865,000 to refinance construction costs originally financed through internally generated funds. The interest rate of this note is 5.76% and is payable monthly for five years calculated on a ten year amortization schedule. A final payment will be due on the maturity date equal to the outstanding principal and interest.
On July 14, 2011, the Company entered into a Multiple Disbursement Term Note and Credit Agreement in the amount of $2 million with Manufacturers and Traders Trust Company to fund construction projects in our NYPSC-mandated repair/replacement program for calendar year 2011. Until October 31, 2011, the note was payable as interest only at a rate of the greater of 3.50% above 30-day LIBOR or 4.25%. On November 1, 2011 the note converted to a permanent loan payable monthly for five years calculated on a ten-year amortization schedule with a variable rate, adjusting daily, based on the greater of 3.25 basis points above 30-day LIBOR or 4.25%.
The Company believes it is in compliance with all of our loan covenants as of September 30, 2011.
Cash flows from financing activities consist of repayment of long-term debt and borrowings and repayments under our lines-of-credit. For our consolidated operations, during 2011, we had $7 million (as of the February 2011 credit agreement renewal) available through lines of credit at local banks, the terms of which are disclosed in Note 5 to the accompanying consolidated financial statements. The amount outstanding under these lines at September 30, 2011 was $4.2 million. The aggregate borrowings at any one time under the revolving line may not exceed the sum of 100% of all eligible accounts receivable plus 100% of all gas inventory plus 50% of miscellaneous eligible inventories (material and supplies on the balance sheet) plus 100% of the value of the Rabbi Trust investment account (a trust to fund a deferred compensation plan for certain officers-see Note 7 to the Notes to Consolidated Financial Statements) up to the $7 million limit. As security for our line of credit, collateral assignments have been executed which assign to the lender various rights in the investment trust account. In addition, our lender has a purchase money interest in all of our natural gas purchases utilizing funds advanced by the bank under the line-of-credit agreement and all proceeds of sale of the gas to customers and related accounts receivable. We rely heavily on our credit lines and large portions of them are utilized throughout the entire year.
On September 30, 2011 we had $12.5 million in long term debt outstanding. We repaid $1.1 million during fiscal 2011 consistent with the requirements of our debt instruments and refinancing activities.
On September 30, 2010 we had $9.6 million in long term debt outstanding. We repaid $1.1 million during fiscal 2010 consistent with the requirements of our debt instruments and refinancing activities.
In 2008 we entered in to an agreement with Atmos Energy Marketing LLC until March 2011. ConocoPhillips became our asset manager in April 2011. As of September 30, 2011, we had 615,353 dekatherms at $2.8 million in storage. In 2010 we ended the year with 604,920 dekatherms at $2.7 million in storage. The higher inventory value in 2011 is directly related to higher volumes. As the result of these actions, we anticipate that we will have sufficient gas to supply our customers for the 2011-2012 winter heating season.
Other Comprehensive Income
Other comprehensive income ("OCI") is comprised of unrealized gains or losses on securities available for sale as required by FASB ASC 320 and pension liability adjustments as required by FASB ASC 715. A drop from 6.75 % to 5.50 % in the discount rate resulted in a $1.9 million pension liability adjustment and a related $1.9 million OCI loss in 2009. There was also a drop in the discounts rate from 5.5% to 5.25% in 2010. That drop was offset by changes in assumptions in the rate of compensation increase from 4.5% to 3% and fund performance that resulted in a $679,023 OCI gain for the period ending September 30, 2010 related to pension liability adjustments. For the period ending September 30, 2011, there was again a drop in the discount rate from 5.25% to 5% which contributed to an associated OCI loss of $321,993 for the period. For additional information, see Note 7 to the Notes to the Consolidated Financial Statements.
Off Balance Sheet Arrangements
We have no off balance sheet arrangements.
Contractual Obligations
Long-term Debt
The fair market value of our long-term debt is estimated based on quoted market prices of similar issues having the same remaining maturities, redemption terms and credit ratings. Notes payable to banks are stated at cost, which approximates their value due to the short-term maturities of those financial instruments. Based on these criteria, the fair market value of long-term debt, including current portion, was as follows at September 30, 2011, 2010 and 2009:
                                                     2011        2010        2009  Unsecured senior note - 7.9%, due serially with annual payments of $355,000 beginning on         $2,570,000 $2,925,000   $3,280,000 September 1, 2006 through 2016 and $795,000 due in 2017 Term Loan - variable rate 1/2 point below prime, monthly installments through August 2010                          -          -      316,650 Note payable - 6.5% with monthly installments     5,050,408  5,487,679    5,821,654 through 2013 Note payable - variable rate with 4.5% floor with monthly installments through May 2015                       928,249  1,018,363            - M&T Bank - new truck loan                             2,995      9,786       16,122 M&T Bank - excavator & radio equipment                6,066     17,285       27,686 M&T Bank - backhoe & skidsteer loader                21,835     46,493       69,353 M&T Bank - used truck loan                                -          -        4,499 Community Bank - used trucks (5) loan                     -     19,980       45,335 M&T Bank - used truck loan                            6,854      8,902       10,813 M&T Bank - used truck loan                            8,124     14,196            - M&T Bank - vehicles loan                             54,220     80,127            - Note Payable - 5.76% with monthly installments through November 2015                                     1,747,565          -            - M&T Bank - used truck loan                            9,252          -            - Note Payable - variable rate with 4.25% floor, monthly installments through November 2016                2,000,000          -            - M&T Bank - new trucks loan                           48,396          -            - M&T Bank - used vehicle loan                         11,089          -            - M&T Bank - equipment loan                            14,811          -            - Total long-term debt                            $12,479,864 $9,627,811   $9,592,112  Less current installments                           945,063    971,417      918,696 
Long-term debt less current installments        $11,534,801$8,656,394$8,673,416
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The aggregate maturities of long-term debt for each of the five years subsequent to September 30, 2011 are as follows:
                           2012                        $945,063                           2013                        $996,437                           2014                      $1,018,345                           2015                      $1,052,491            2016 and thereafter                      $8,467,527
The estimated interest payments on the above debts are as follows:
                           2012                        $734,603                           2013                        $664,666                           2014                        $578,851                           2015                        $491,257                           2016                        $401,223
The estimated pension plan payments are as follows:
                           2012                        $862,000                           2013                        $873,000                           2014                        $907,000                           2015                        $942,000                           2016                      $1,060,000   Lines of Credit 
The Company had a line of credit with Community Bank, N.A. to borrow up to $8 million on a short-term basis. In March 2010 and again in April 2011, we renewed our line of credit with a limit of $7 million. Under this agreement, the aggregate borrowings at any one time under the revolving line may not exceed the sum of 100% of all eligible accounts receivable plus 100% of all gas inventory plus 50% of miscellaneous eligible inventories (material and supplies on the balance sheet) plus 100% of the value of the Rabbi Trust investment account up to the $7.0 million limit. Borrowings outstanding under this line were $4,178,784, $5,140,649 and $6,756,560 at September 30, 2011, 2010 and 2009, respectively. The maximum amount outstanding during the year ended September 30, 2011, 2010 and 2009 was $6,246,562, $7,437,118 and $6,877,870 respectively. On September 3, 2009, due to market conditions, the interest rate formula was changed to the greater of 4% or 225 basis points above 30 days LIBOR. In February 2011, we negotiated the new rate formula as a fluctuating rate equal to the greater of 3.5% or the 30-day LIBOR plus 2.25%. The line of credit is payable on demand with an interest rate of 3.5% on September 30, 2011. As security for the Company's line of credit, collateral assignments have been executed which assign to Community Bank, N.A. various rights in the investment trust account. In addition, Community Bank, N.A. has a purchase money interest in all of our natural gas purchases utilizing funds advanced by the bank under the line-of-credit agreement and all proceeds of sale of the gas to customers and related accounts receivable. The weighted average interest rates on outstanding borrowings during fiscal 2011, 2010 and 2009 were 3.78%, 4% and 2.98% respectively.
As of September 30, 2011, we believe that cash flow from operating activities, borrowings under our lines of credit and new debt instruments and proceeds from equity will be sufficient to satisfy our working capital, capital expenditures, debt requirements and to finance our internal growth needs for the next twelve months.
Interest Rate Risk
Our exposure to interest rate risk arises from borrowing under short-term debt instruments. At September 30, 2011, these instruments consisted of a bank credit line of $7 million with an interest rate of 3.5%. Tied to the higher of 3.5% or 225 basis points above LIBOR, the rate could remain unchanged for months.
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Regulatory Matters
The Company's business is regulated by the NYPSC among other agencies.
In August 2009, in Case 08-G-1137, the NYSPC approved a rate increase of $1.5 million effective September 1, 2009 that was included in a gas rate joint proposal dated March 27, 2009. The order also contained a revenue decoupling mechanism (RDM) and a year two "capital tracker". As discussed below in this section, this allowed the Company to file for second stage rate relief in 2010 for new capital projects without a full blown rate proceeding. In addition, the percentage of producer revenue retained by the Company as an incentive was increased from 10% to 20%.
On September 18, 2009, in Case 09-G-0488, the NYPSC approved the Company's petition to issue long term indebtedness in the principal amount of $7,000,000 for the purpose of refunding existing obligations and financing new construction.
On November 25, 2008, the Federal Energy Regulatory Commission (FERC) approved the Company's Service Area Determination Pursuant to Section 7(f) of the Natural Gas Act under Docket CP08-472-000. This granted the Company the authority to cross into the State of Pennsylvania to connect to Marcellus Shale gas. As a result, the Company may transport gas from Pennsylvania via a new pipeline constructed to interconnect with the Company's New York distribution system. On October 23, 2009, the FERC approved the Company's application under Section 7(c) of the Natural Gas Act and Section 284.224 of the FERC's regulations for a limited jurisdiction blanket certificate to sell and transport natural gas in interstate commerce. Under Section 284.224, the Company, a local distribution company (LDC), and Hinshaw pipeline (exempt from FERC jurisdiction), is authorized to perform the same types of transactions which intrastate pipelines are authorized to perform under Section 311 of the Natural Gas Policy Act. This will allow the Company to transport under our market area determination from Pennsylvania to New York State and then inject gas not needed locally into interstate pipelines.
On October 26, 2009, the Company filed a petition in Case 09-G-0791 seeking a determination by the NYPSC as to the appropriate accounting for costs and revenues associated with facilities that will be used to transport substantial additional quantities of natural gas from gas producers. On January 11, 2010, the Company entered into a contract with a local gas producer, Talisman Energy USA Inc., that provides for the building of a compressor station as well as the transfer of a 6" pipeline owned by Talisman to the Company (see note regarding NYPSC approval of the compressor station below). The contract that was filed with the NYPSC also sets forth the terms, rates and conditions for the transportation of the local producer gas to the interstate pipeline system. The Company filed an updated economic analysis for the project based on the contract terms in support of the Company's petition for determination of the appropriate accounting for costs and revenues associated with the facilities. The Commission issued an order on June 25, 2010 setting forth the accounting for the revenues from the compressor station project. The Commission determined that 80% of the project revenue should be used to write down project investment and that 20% be retained by the Company as an incentive. Once the plant is fully written down, 80% of the revenue will be deferred for the benefit of the customer. The disposition of the deferred customer benefit will be determined by the NYPSC. The Commission denied the Company's request to accrue carrying charges on the unrecovered investment until those costs were reflected in rates.
On November 2, 2009, the Company filed a petition in Case 09-G-0790 for authority to transfer its pipelines 2, 3 and 6 from utility operations to a non-utility entity. These pipeline facilities are not currently needed for the Company to provide its natural gas distribution service. In the future, however, these facilities may be useful for the purpose of transporting locally produced natural gas, a business distinct from the Company's provision of distribution service. The Commission has not acted on the Company's petition.
On January 13, 2010, the Company and Talisman filed a joint application with the NYPSC to transfer the New York Public Service Law Article VII Certificate, that had permitted the construction and operation of the 6" pipeline referred to above, from Talisman to the Company and to amend the Article VII Certificate to permit the construction of a compressor station in the Town of Caton, New York. On July 26, 2010, the NYPSC approved the transfer and amendment of the Article VII Certificate. This order provides for the transfer of the 6" pipeline and grants the Company the authority to build the compressor station in Caton. It also permits the upgrade of certain Company pipeline facilities. This order will facilitate the movement of Marcellus Shale gas into and through the Company's pipelines.
On May 17, 2010, the Company filed a petition with the NYPSC in Case 10-G-0224 for a declaratory ruling on the applicability of the 2009 amendments to Section 70 of the Public Service Law to certain stock transactions. The amendment requires approval of the NYPSC for the purchase of common stock holdings of greater than 10% by individuals and certain entities. At the time, there were only three shareholders, including related groups of shareholders, holding more than 10 percent of the Company's common stock: The Gabelli Group of Rye, New York; Michael I. German, the Company's President and Chief Executive Officer; and Richard M. Osborne of Mentor, Ohio, the Company's former Chairman. Additional purchases through the Company's dividend reinvestment plan and upon exercise of subscription rights issued in the rights offering by these individuals were approved by the NYPSC in an order dated August 20, 2010. The Order also approved transactions for the exercise of certain stock options. However, that Order did not specifically address Corning's request for approval of the exercise by the Chief Executive Officer of pre-2009 options to purchase the additional 56,000 shares of common stock available at that time. The Company sought clarification or rehearing of the August 20, 2010 Order to address the pre-2009 options. In an Order issued November 19, 2010, the NYPSC determined that the exercise of the options would not result in the type of ownership concentration that would violate the public interest. The Company's Chief Executive Officer currently owns 21.59% of the outstanding shares of common stock of the Company. Were he to exercise his rights to the fullest extent (33,000 shares adjusted for the stock dividend issued on April 20, 2011) his ownership interest would increase to 22.99%.
On November 17, 2010, Bath Electric Gas & Water Systems (BEGWS), a natural gas customer of the Company, filed a petition with the NYPSC, in Case 10-G-0598 that claimed BEGWS was overbilled for gas by the Company. BEGWS asserted that the Company's meters registered 2.94% more gas than was actually delivered to BEGWS from 2004 through 2010. Based on its calculations, BEGWS has requested that the NYPSC order the Company to refund approximately $1.2 million for overcharges and interest. The Company conducted a comprehensive review of the BEGWS claim. The Company installed new meters for BEGWS in 2009 and believes that those meters and the resulting bills have been accurate. On January 26, 2011, the Company responded that its preliminary review of its billing data and gas cost reconciliation to the NYPSC shows that the Company has already credited BEGWS the amount in the claim. In testimony filed by its consultants on July 8, 2011, BEGWS acknowledged receipt of the amount in the claim but raised new claims not in the original petition. BEGWS now asserts that the Company owes it a refund of $345,747. The Company plans to contest the testimony filed on July 8, 2011. The Company and BEGWS met with the Staff on July 11, 2011, to discuss findings to date on the petition. No order has been issued by the NYPSC on this matter. The meter investigation associated with the petition is ongoing. Currently, the Company does not believe that the BEGWS petition, whether it is granted or not, would have a material financial impact.
The NYPSC on January 25, 2011 acted on the Company's second stage request in Case 08-G-1137. The amount of the second stage was estimated to be approximately $164,000. The actual amount of the second stage rate increase will be determined via a reconciliation process that covers September 2010 to August 2011. If eligible expenditures and costs recoverable in the second stage exceed the forecast used by the NYPSC to set the cash collection amount, those amounts will be deferred and recovered via the Delivery Rate Adjustment in 2012. The NYPSC denied the Company's request to extend the second stage calculation mechanism to a third and fourth stage. This denial necessitated the filing of a base rate case in the first half of calendar year 2011 (Case 11-G-0280, discussed below). The Company filed for re-hearing on February 1, 2011. The petition stated that the NYPSC erred in not including depreciation expense as a component of carrying costs recoverable in the second stage rate increase. On October 13, 2011, the NYPSC denied the Company's rehearing request.
The Joint Proposal in Case 08-G-1137, as approved by the NYPSC in August 2009, permitted the Company to seek rate treatment for the Root pipeline (line 13) that went into service in early 2009 to transport Marcellus Shale gas from Pennsylvania to the Company's system in New York. In 2009, subsequent to approval of the Joint Proposal, the Company filed a request for a declaratory ruling to permit the Company to retain revenues derived from the transportation charges for the new pipeline from January 1, 2009 through August 31, 2009, the period prior to the effective date of new rates. In the absence of such relief, the Company would be required to pay the carrying cost of the pipeline during that period without a commensurate opportunity to recover those costs through retention of revenues. In an order issued March 29, 2010 in Cases 09-G-0813 and 07-G-0772, the NYPSC denied the declaratory ruling request. The Company sought rehearing in a petition filed April 27, 2010. The NYPSC, in an order issued January 25, 2011, denied the request for rehearing. There will be no future impact on revenues since the Company has already made the appropriate adjustment.
On March 17, 2011, the NYPSC issued an order in Case 10-G-0647 authorizing the Company to issue and distribute a fifty percent stock dividend to its shareholders. On March 21, 2011, the Company set April 1, 2011 as the record date for a one for two stock dividend on its outstanding common stock as authorized by the NYPSC order. Each shareholder of record as of close of business on the record date was paid one share of common stock for each two shares held by such holder on April 20, 2011.
On April 14, 2011, the NYPSC issued an order in Case 08-G-1137 for the accounting treatment and new schedule for line 15 upgrades. The Company had requested that carrying costs (defined as pre-tax overall return, depreciation expense and property taxes) be permitted on the mandated reliability upgrade until the investment was reflected in base rates. The NYPSC granted the request in part by allowing carrying costs defined as pre-tax overall return and property taxes. The Company filed for re-hearing on April 18, 2011 stating that the NYPSC erred in not providing for depreciation expense as a component of carrying costs, since the definition above has been applied to other utilities under the NYPSC's jurisdiction. In an Order issued October, 13, 2011, the NYPSC denied the Company's request for re-hearing.
On May 19, 2011, the NYPSC, in Case 08-G-1137, issued an Order Modifying the Regulatory Matrix and Establishing Liability. The order granted, with one exception, the request of Corning Natural Gas Corporation to eliminate the Regulatory Matrix that was originally established in Case 05-G-1359. The NYPSC removed the Regulatory Matrix penalties associated with accounting, leak reporting, and gas supply related requirements; but it continued the cathodic protection reporting requirement and associated penalties of $32,750 per deficiency per year. The order concluded that the Company had failed to submit annual reports for 2009 and 2010, and assessed a total penalty of $65,500 for those asserted failures. On June 3, 2011, the Company filed a petition for re-hearing requesting that the penalty determination pertaining to cathodic protection reporting be rescinded, or in the alternative, that the issue of the penalty be incorporated into the Company's base rate case (Case 11-G-0280). On October 13, 2011 the NYPSC denied the Company's rehearing request. The Staff of the NYPSC in Case 11-G-0280 is recommending that the penalty amount be amortized over a seven year period. This matter will be decided with the rate case order.
On May 24, 2011, the Company filed Case 11-G-0280, a base rate case that requested an increase in revenues of $1,429,281 (or 6.63% on an overall bill rate basis) in the 12 months ending April 30, 2013, (the Rate Year) and by the same dollar amount in the two succeeding 12-month periods (ending April 30, 2014, and April 30, 2015). This multi-year proposal is a levelized alternative to a single-year increase of $2,565,649 in the Rate Year and $901,464 and $583,033 for the years ending April 30, 2014, and April 30, 2015, respectively. It also asked that the Commission permit increases for certain limited expenditures (capital additions and property taxes) for the 12-month periods ending April 30, 2016, and April 30, 2017. The Company proposed to offset the annualized amount by an $844,000 credit that represents the forecasted customer share of the revenues from transportation of local production gas including operation of the associated compressor facilities. If the Company's credit proposal is adopted by the Commission, the overall bill impact on customer bills will be an increased 2.71%. The Company in the filing requested a Return on Equity Capital of 10.9 %.
On July 11, 2011, a pre-hearing conference in Case 11-G-0280 was held in Albany, New York, before the NYPSC's Administrative Law Judges ("ALJs") for the purpose of establishing a hearing schedule for the current rate case. The Staff, the Company and other parties presented a proposed schedule to the ALJs at that meeting. The schedule proposed by the parties was adopted by the ALJs by ruling dated July 13, 2011. A NYPSC decision in the rate case is expected by May 1, 2012. In testimony and exhibits filed September 23, 2011, the NYPSC Staff and other parties proposed alternatives to the Company's positions on certain issues.
On July 15, 2011, the Staff filed a motion to strike certain passages of the Company's testimony in the rate case. The Staff motion sought to exclude the prepared direct testimony and exhibits of the Company's witnesses as they pertain to the proposed transfer of certain pipeline facilities, the establishment of a holding company structure, and expenditures for the expansion of Coming's franchise in the Town of Virgil. The Company filed a response on July 25, 2011 to oppose Staff's motion on the basis that all of the issues raised by the NYPSC can be properly considered in the rate case. A ruling from the ALJs was issued on August 2, 2011. The ruling granted the Staff's motion insofar as it pertained to the transfer of pipeline facilities and formation of a holding company on the ground that those matters should be addressed in separate proceedings. The ruling denied the Staff's motion to strike evidence on the expansion of the Virgil franchise, concluding that the consideration of the financial aspects of the expansion was appropriate in the pending rate case. In testimony and exhibits filed September 23, 2011, the NYPSC Staff and other parties proposed alternatives to the Company's positions on certain issues. From October 24, 2011 to October 27, 2011, and again from November 7, 2011 to November 9, 2011, the Company met with the NYPSC, Staff and other active parties in Case 11-G-0280 in Albany, New York, for settlement conferences. The purpose of the conferences was to settle some or all of the issues in the Company's pending rate case. The parties reached an agreement in principle and are now working on a detailed settlement document, as well as finalizing agreement on specific issues. A Ruling on Schedule by the ALJ's on December 1, 2011, calls for filing the final settlement agreement by January 13, 2012. Pursuant to NYPSC regulations governing the settlement process, no details regarding the settlement can be disclosed until the full document is publically filed.
On September 15, 2011, the Company filed a petition with the NYPSC seeking amendment of the Certificate of Public Convenience and Necessity (the "Certificate") granted by the NYPSC in its "Order Granting a Certificate of Public Convenience and Necessity" issued June 19, 2009 in Case 09-G-0252 permitting the Company to expand service within the Town of Virgil, Cortland County, beyond those areas in which service was authorized pursuant to the Certificate. It is unknown at this time when the NYPSC will act on the Company's request.
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Critical Accounting Policies
Our significant accounting policies are described in the notes to the accompanying Consolidated Financial Statements of this Form 10-K. The application of generally accepted accounting principles involve certain assumptions, judgments and estimates that affect reported amounts of assets, liabilities, revenues and expenses. Thus, the application of these principles can result in varying results from company to company. The principles and policies that most significantly impact us are discussed below.
Accounting for Utility Revenue and Cost of Gas Recognition
We record revenues from residential and commercial customers based on meters read on a cycle basis throughout each month, while certain large industrial and utility customers' meters are read at the end of each month. We do not accrue revenue for gas delivered but not yet billed, as the NYPSC requires that such accounting be adopted during a rate proceeding, which we have not done. Currently we do not anticipate adopting unbilled revenue recognition nor do we believe it would have a material impact on our financial results. Our tariffs contain mechanisms that provide for the recovery of the cost of gas applicable to firm customers, which includes estimates. Under these mechanisms, we periodically adjust rates to reflect increases and decreases in the cost of gas. Annually, we reconcile the difference between the total gas costs collected from customers and the cost of gas. We defer any excess or deficiency and subsequently either recover it from, or refund it to, customers over the following twelve-month period. To the extent estimates are inaccurate; a regulatory asset on the balance sheet is increased or decreased.
Accounting for Regulated Operations - Regulatory Assets and Liabilities
All of our business is subject to regulation by NYPSC. We record the results of our regulated activities in accordance with Financial Accounting Standards Board (FASB) ASC 980 (prior authoritative literature: Statement of Financial Accounting Standards (SFAS) No. 71, "Accounting for the Effects of Certain Types of Regulation"), which results in differences in the application of generally, accepted accounting principles between regulated and non-regulated businesses. FASB ASC 980 requires the recording of regulatory assets and liabilities for certain transactions that would have been treated as revenue and expense in non-regulated businesses. In certain circumstances, FASB ASC 980 allows entities whose rates are determined by third-party regulators to defer costs as "regulatory" assets in the balance sheet to the extent that the entity expects to recover these costs in future rates. Management believes that currently available facts support the continued application of FASB ASC 980 and that all regulatory assets and liabilities are recoverable or refundable through the regulatory environment.
Accounting for the Compressor Station
The Company bought the $11 million compressor station and $2.1 million pipeline from a local producer for two dollars. Although the Company has $13.1 million in new plant, only two dollars was recognized on the Balance Sheet in accordance with the Uniform System of Accounts (313.2) which states that in the case of gas plant contributed to the utility, gas plant accounts shall be charged only with such expenses, if any, incurred by the utility. Please see Note (q) 311 Transportation Agreement/Compressor Station for more details.
Pension and Post-Retirement Benefits
The amounts reported in our financial statements related to pension and other post-retirement benefits are determined on an actuarial basis, which requires the use of many assumptions in the calculation of such amounts. These assumptions include the discount rate, the expected return on plan assets, the rate of compensation increase and, for other post-retirement benefits, the expected annual rate of increase in per capita cost of covered medical and prescription benefits. Changes in actuarial assumptions and actuarial experience could have a material impact on the amount of our pension and post-retirement benefit costs and funding requirements. However, we expect to recover substantially all our net periodic pension and other post-retirement benefit costs attributed to employees in accordance with NYPSC authorization. For financial reporting purposes, the difference between the amounts of such costs as determined under applicable accounting principles is recorded as either a regulatory asset or liability.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This report contains statements which, to the extent they are not recitations of historical facts, constitute "forward-looking statements" within the meaning of the Securities Litigation Reform Act of 1995 (Reform Act). In this respect, the words "estimate", "project", "anticipate", "expect", "intend", "believe", "could" and similar expressions are intended to identify forward-looking statements. All such forward-looking statements are intended to be subject to the safe harbor protection provided by the Reform Act. Although we believe that the expectations reflected in these forward-looking statements are based on reasonable assumptions, we can give no assurance that our expectations will be achieved. As forward-looking statements, these statements involve risks, uncertainties and other factors that could cause actual results to differ materially from the expected results. Accordingly, actual results may differ materially from those expressed in any forward-looking statements. Factors that could cause results to differ materially from our management's expectations include, but are not limited to, those listed under Item 1A - "Risk Factors", above, in addition to:
 *  The effect of any interruption in our supply of natural gas or a substantial    increase in the price of natural gas, *  Our ability to successfully negotiate new supply agreements for natural gas as    they expire, on terms favorable to us, or at all, *  The effect of any litigation arising from actions taken or not taken by former    executive officers and any agreements executed in connection therewith,    The effect on our operations of unexpected changes in any other applicable    legal or regulatory requirements, *  The amount of natural gas produced and directed    through our pipeline by producers, *  Our ability to obtain additional equity or debt financing to fund our capital    expenditure plans and for general corporate purposes, *  Our successful completion of various capital projects and the use of pipeline,    compressor stations and storage by customers and counterparties at levels    consistent with our expectations, *  Our ability to retain the services of our senior executives and other key    employees, *  Our vulnerability to adverse general economic and industry conditions    generally and particularly the effect of those conditions on our major    customers, *  The effect of any leaks in our transportation and delivery pipelines, and *  Competition to our gas supply and transportation business from other    pipelines.  
Forward-looking statements speak only as of the date they are made, and we undertake no obligation to update any forward-looking statement in light of new information or future events.
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