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EX-32.2 - EXHIBIT 32.2 - SOUTH JERSEY GAS Cosjg-63016ex322.htm
EX-32.1 - EXHIBIT 32.1 - SOUTH JERSEY GAS Cosjg-63016ex321.htm
EX-31.2 - EXHIBIT 31.2 - SOUTH JERSEY GAS Cosjg-63016ex312.htm
EX-31.1 - EXHIBIT 31.1 - SOUTH JERSEY GAS Cosjg-63016ex311.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-Q
(Mark one)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2016

OR

o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________________ to ________________

Commission File Number 000-22211

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

New Jersey
 
21-0398330
(State of incorporation)
 
(IRS employer identification no.)

1 South Jersey Plaza, Folsom, NJ 08037
(Address of principal executive offices, including zip code)

(609) 561-9000
(Registrant's telephone number, including area code)


Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x      No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x      No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o
Accelerated filer o
Non-accelerated filer x (Do not check if a smaller reporting company)
Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o    No x
  
As of August 1, 2016 there were 2,339,139 shares of the registrant’s common stock outstanding, all of which are owned by South Jersey Industries, Inc., the parent company of South Jersey Gas Company.



TABLE OF CONTENTS

 
Page No.
 
 
PART I
FINANCIAL INFORMATION
 
 
 
 
Item 1.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
PART II
OTHER INFORMATION
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 6.
 
 
 
  

2




SOUTH JERSEY GAS COMPANY

CONDENSED STATEMENTS OF INCOME (UNAUDITED)
(In Thousands)

 
 
Three Months Ended
 
June 30,
 
2016
 
2015
Operating Revenues
$
68,762

 
$
75,812

 
 
 
 
Operating Expenses:
 

 
 

Cost of Sales (Excluding depreciation)
19,997

 
25,419

Operations
22,525

 
23,939

Maintenance
4,259

 
3,928

Depreciation
11,490

 
9,711

Energy and Other Taxes
560

 
854

 
 
 
 
Total Operating Expenses
58,831

 
63,851

 
 
 
 
Operating Income
9,931

 
11,961

 
 
 
 
Other Income and Expense
1,079

 
1,670

 
 
 
 
Interest Charges
(4,552
)
 
(5,113
)
 
 
 
 
Income Before Income Taxes
6,458

 
8,518

 
 
 
 
Income Taxes
(1,415
)
 
(3,292
)
 
 
 
 
Net Income
$
5,043

 
$
5,226

 
The accompanying notes are an integral part of the unaudited condensed financial statements.





3



 
 
 
 
 
Six Months Ended
 
June 30,
 
2016
 
2015
Operating Revenues
$
256,528

 
$
343,470

 
 
 
 
Operating Expenses:
 

 
 

Cost of Sales (Excluding depreciation)
89,300

 
171,521

Operations
48,594

 
57,297

Maintenance
8,643

 
7,926

Depreciation
22,700

 
19,302

Energy and Other Taxes
1,587

 
2,274

 
 
 
 
Total Operating Expenses
170,824

 
258,320

 
 
 
 
Operating Income
85,704

 
85,150

 
 
 
 
Other Income and Expense
1,915

 
2,430

 
 
 
 
Interest Charges
(9,339
)
 
(10,303
)
 
 
 
 
Income Before Income Taxes
78,280

 
77,277

 
 
 
 
Income Taxes
(28,819
)
 
(29,464
)
 
 
 
 
Net Income
$
49,461

 
$
47,813


The accompanying notes are an integral part of the unaudited condensed financial statements.


4


SOUTH JERSEY GAS COMPANY

CONDENSED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
(In Thousands)
 
 
Three Months Ended
 
June 30,
 
2016
 
2015
Net Income
$
5,043

 
$
5,226

 
 
 
 
Other Comprehensive Income (Loss) - Net of Tax: *
 

 
 

 
 
 
 
Unrealized Gain (Loss) on Available-for-Sale Securities
3

 
(37
)
Unrealized Gain on Derivatives - Other
7

 
7

 
 
 
 
Other Comprehensive Income (Loss) - Net of Tax *
10

 
(30
)
 
 
 
 
Comprehensive Income
$
5,053

 
$
5,196

 
 
 
 

 
 
 
 
 
Six Months Ended
 
June 30,
 
2016
 
2015
Net Income
$
49,461

 
$
47,813

 
 
 
 
Other Comprehensive Income - Net of Tax: *
 

 
 
 
 
 
 
Unrealized Gain on Available-for-Sale Securities
7

 
17

Unrealized Gain on Derivatives - Other
14

 
9

 
 
 
 
Other Comprehensive Income - Net of Tax *
21

 
26

 
 
 
 
Comprehensive Income
$
49,482

 
$
47,839

 
 
 
 
* Determined using a combined average statutory tax rate of 40%.
 
The accompanying notes are an integral part of the unaudited condensed financial statements.

5


SOUTH JERSEY GAS COMPANY

CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In Thousands)
 
 
Six Months Ended
 
June 30,
 
2016
 
2015
Net Cash Provided by Operating Activities
$
97,394

 
$
89,031

 
 
 
 
Cash Flows from Investing Activities:
 

 
 

Capital Expenditures
(107,676
)
 
(95,861
)
Note Receivable
(74
)
 
(9,887
)
Net Sale (Purchase) of Restricted Investments in Margin Accounts
6,737

 
1,969

Investment in Long-Term Receivables
(5,702
)
 
(3,381
)
Proceeds from Long-Term Receivables
5,195

 
2,040

 
 
 
 
Net Cash Used in Investing Activities
(101,520
)
 
(105,120
)
 
 
 
 
Cash Flows from Financing Activities:
 

 
 

Net (Repayments of) Borrowings from Short-Term Credit Facilities
(121,100
)
 
26,200

Proceeds from Issuance of Long-Term Debt
61,000

 

Dividends on Common Stock

 
(9,891
)
Additional Investment by Shareholder
65,000

 

 
 
 
 
Net Cash Provided by Financing Activities
4,900

 
16,309

 
 
 
 
Net Increase in Cash and Cash Equivalents
774

 
220

Cash and Cash Equivalents at Beginning of Period
775

 
1,778

 
 
 
 
Cash and Cash Equivalents at End of Period
$
1,549

 
$
1,998

 
The accompanying notes are an integral part of the unaudited condensed financial statements.

6


SOUTH JERSEY GAS COMPANY

CONDENSED BALANCE SHEETS (UNAUDITED)
(In Thousands)
 
 
June 30,
2016
 
December 31,
2015
Assets
 
 
 
Property, Plant and Equipment:
 
 
 
Utility Plant, at original cost
$
2,310,223

 
$
2,211,239

Accumulated Depreciation
(459,015
)
 
(440,473
)
 
 
 
 
Property, Plant and Equipment - Net
1,851,208

 
1,770,766

 
 
 
 
Investments:
 

 
 

Available-for-Sale Securities
8,996

 
8,788

Restricted Investments
32

 
6,769

 
 
 
 
Total Investments
9,028

 
15,557

 
 
 
 
Current Assets:
 

 
 

Cash and Cash Equivalents
1,549

 
775

Note Receivable
9,990

 
9,916

Accounts Receivable
66,635

 
64,445

Accounts Receivable - Related Parties
1,243

 
1,972

Unbilled Revenues
14,657

 
25,613

Provision for Uncollectibles
(9,761
)
 
(9,778
)
Natural Gas in Storage, average cost
9,198

 
14,294

Materials and Supplies, average cost
950

 
937

Prepaid Taxes
26,448

 
21,483

Derivatives - Energy Related Assets
3,573

 
1,077

Other Prepayments and Current Assets
16,090

 
13,405

 
 
 
 
Total Current Assets
140,572

 
144,139

 
 
 
 
Regulatory and Other Noncurrent Assets:
 

 
 

Regulatory Assets
380,364

 
323,434

Long-Term Receivables
25,504

 
24,950

Derivatives - Energy Related Assets
554

 
64

Other
3,292

 
2,666

 
 
 
 
Total Regulatory and Other Noncurrent Assets
409,714

 
351,114

 
 
 
 
Total Assets
$
2,410,522

 
$
2,281,576

 
The accompanying notes are an integral part of the unaudited condensed financial statements.

7


SOUTH JERSEY GAS COMPANY

CONDENSED BALANCE SHEETS (UNAUDITED)
(In Thousands, except per share amounts)
 
 
June 30,
2016
 
December 31,
2015
Capitalization and Liabilities
 
 
 
Common Equity:
 
 
 
Common Stock, Par Value $2.50 per share:
 
 
 
Authorized - 4,000,000 shares
 
 
 
Outstanding - 2,339,139 shares
$
5,848

 
$
5,848

Other Paid-In Capital and Premium on Common Stock
315,827

 
250,827

Accumulated Other Comprehensive Loss
(12,841
)
 
(12,862
)
Retained Earnings
513,575

 
464,114

 
 
 
 
Total Common Equity
822,409

 
707,927

 
 
 
 
Long-Term Debt (see Note 1)
438,820

 
577,454

 
 
 
 
Total Capitalization
1,261,229

 
1,285,381

 
 
 
 
Current Liabilities:
 

 
 

Notes Payable
13,300

 
134,400

Current Portion of Long-Term Debt
227,909

 
27,909

Accounts Payable - Commodity
10,341

 
8,936

Accounts Payable - Other
31,947

 
40,579

Accounts Payable - Related Parties
7,465

 
7,552

Derivatives - Energy Related Liabilities
4,694

 
5,489

Derivatives - Other Current
529

 

Customer Deposits and Credit Balances
21,952

 
19,531

Environmental Remediation Costs
70,295

 
48,323

Taxes Accrued
1,550

 
1,930

Pension Benefits
2,227

 
2,227

Interest Accrued
6,137

 
5,989

Other Current Liabilities
2,953

 
5,686

 
 
 
 
Total Current Liabilities
401,299

 
308,551

 
 
 
 
Regulatory and Other Noncurrent Liabilities:
 

 
 

Regulatory Liabilities
60,010

 
42,841

Deferred Income Taxes - Net
463,588

 
432,674

Environmental Remediation Costs
82,054

 
74,871

Asset Retirement Obligations
58,293

 
57,219

Pension and Other Postretirement Benefits
68,708

 
65,491

Derivatives - Energy Related Liabilities
3

 
351

Derivatives - Other Noncurrent
9,834

 
7,631

Other
5,504

 
6,566

 
 
 
 
Total Regulatory and Other Noncurrent Liabilities
747,994

 
687,644

 
 
 
 
Commitments and Contingencies (Note 9)


 


 
 
 
 
Total Capitalization and Liabilities
$
2,410,522

 
$
2,281,576

 
The accompanying notes are an integral part of the unaudited condensed financial statements.

8


NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS

1.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

THE ENTITY - South Jersey Industries, Inc. (SJI) owns all of the outstanding common stock of South Jersey Gas Company (SJG or the Company), a regulated natural gas utility. SJG distributes natural gas in the seven southern most counties of New Jersey. In our opinion, the condensed financial statements reflect all normal and recurring adjustments needed to fairly present our financial position and operating results at the dates and for the periods presented. SJG’s business is subject to seasonal fluctuations, and accordingly, this interim financial information should not be the basis for estimating the full year’s operating results. As permitted by the rules and regulations of the Securities and Exchange Commission, the accompanying condensed financial statements contain certain condensed financial information and exclude certain note disclosures normally included in annual audited financial statements prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). These condensed financial statements should be read in conjunction with SJG’s Annual Report on Form 10-K for the year ended December 31, 2015 for a more complete discussion of our accounting policies and certain other information.

Certain reclassifications have been made to the prior period's condensed balance sheets, as well as the prior period's long-term debt carrying value in Note 6, to conform to the current period presentation. The unamortized debt issuance costs previously included in "Regulatory and Other Noncurrent Assets" on the condensed balance sheets were reclassified to Long-Term Debt to conform to ASU 2015-03, which is described below under "New Accounting Pronouncements." This reclassification caused the prior period long-term debt carrying value in Note 6 to be adjusted.

REVENUE - BASED TAXES - SJG collects certain revenue-based energy taxes from its customers. Such taxes include the New Jersey State Sales Tax 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. The PUA is included in both revenues and energy and other taxes, and totaled $0.2 million for both the three months ended June 30, 2016 and 2015, and $0.5 million and $0.8 million for the six months ended June 30, 2016 and 2015, respectively.

NEW ACCOUNTING PRONOUNCEMENTS — Other than as described below, no new accounting pronouncement issued or effective during 2016 or 2015 had, or are expected to have, a material impact on the condensed financial statements.

In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (Topic 606). This ASU supersedes the revenue recognition requirements in FASB ASC 605, Revenue Recognition, and in most industry-specific topics. The new guidance identifies how and when entities should recognize revenue. The new rules establish a core principle requiring the recognition of revenue to depict the transfer of promised goods or services to customers in an amount reflecting the consideration to which the entity expects to be entitled in exchange for such goods or services. The new guidance is effective for fiscal years, and interim periods within those annual periods, beginning after December 15, 2017. Management has formed an implementation team that is currently inventorying the contracts with customers and evaluating the impact that adoption of this guidance will have on the Company's financial statement results, as well as the transition method the Company will elect to adopt the guidance.

In August 2014, the FASB issued ASU 2014-15, Presentation of Financial Statements - Going Concern (Subtopic 205-40); Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern. The new guidance requires management of a company to evaluate whether there is substantial doubt about the company's ability to continue as a going concern. This ASU is effective for the annual reporting period ending after December 15, 2016, and for interim and annual reporting periods thereafter, with early adoption permitted. Management does not expect this standard to have an impact on the Company's financial statements upon adoption.

In April 2015, the FASB issued ASU 2015-03, Interest-Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs. This ASU requires debt issuance costs to be presented in the balance sheet as a direct deduction from the associated debt liability. The standard is effective for annual periods, including interim periods within those annual periods, beginning after December 15, 2015. Adoption of this guidance did not have an impact on the Company's results of operations; however, balance sheet presentations were modified to conform to this guidance.

In July 2015, the FASB issued ASU 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory. This ASU states that inventory for which cost is determined using a method other than last-in, first-out (LIFO) or the retail method should be subsequently measured at the lower of cost or net realizable value (NRV), rather than at the lower of cost or market. The standard is effective for annual periods, including interim periods within those annual periods, beginning after December 15, 2016. Management is currently determining the impact that adoption of this guidance will have on the Company's financial statement results.

9



In January 2016, the FASB issued ASU 2016-01, Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, which enhances the reporting model for financial instruments and includes amendments to address aspects of recognition, measurement, presentation and disclosure. The standard is effective for annual periods, including interim periods within those annual periods. beginning after December 15, 2017. Early adoption is permitted for only certain portions of the new guidance. Management is currently determining the impact that adoption of this guidance will have on the Company's financial statement results.

In March 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which establishes a new lease accounting model for lessees. The new standard requires substantially all leases be recognized by lessees on their balance sheet as a right-of-use asset and corresponding lease liability, including leases currently accounted for as operating leases. The new standard also will result in enhanced quantitative and qualitative disclosures, including significant judgments made by management, to provide greater insight into the extent of revenue and expense recognized and expected to be recognized from existing leases. The accounting for leases by the lessor remains relatively the same. The standard is effective for annual periods, including interim periods within those annual periods, beginning after December 15, 2018, with early adoption permitted. Management is currently determining the impact that adoption of this guidance will have on the Company's financial statement results.

In March 2016, the FASB issued ASU 2016-05, Derivatives and Hedging (Topic 815): Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships. The amendments in this guidance clarify that a change in the counterparty to a derivative instrument that has been designated as a hedging instrument under Topic 815 does not, in and of itself, require dedesignation of that hedging relationship provided that all other hedge accounting criteria continue to be met. The standard is effective for annual periods, including interim periods within those annual periods, beginning after December 15, 2016, with early adoption permitted. Management is currently determining the impact that adoption of this guidance will have on the Company's financial statement results.

In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net). This standard amends ASU 2014-09 (discussed above), to improve the implementation guidance on principal versus agent considerations and whether an entity reports revenue on a gross or net basis. This standard will have the same effective date and transition requirements as ASU 2014-09. Management is currently determining the impact that adoption of this guidance will have on the Company's financial statement results.

In March 2016, the FASB issued ASU 2016-09, Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, which simplifies various aspects of accounting for share-based payment arrangements. The standard is effective for annual periods, including interim periods within those annual periods, beginning after December 15, 2016, with early adoption permitted. Management is currently determining the impact that adoption of this guidance will have on the Company's financial statement results.

In April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing. This standard amends ASU 2014-09 (discussed above) to clarify identifying performance obligations and the licensing implementation guidance. This standard will have the same effective date and transition requirements as ASU 2014-09. Management is currently determining the impact that adoption of this guidance will have on the Company's financial statement results.

In May 2016, the FASB issued ASU 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients. This standard amends ASU 2014-09 (discussed above) to provide additional guidance on (a) the objective of the collectibility criterion, (b) the presentation of sales tax collected from customers, (c) the measurement date of non-cash consideration received, (d) practical expedients in respect of contract modifications and completed contracts at transition, and (5) disclosure of the effects of the accounting change in the period of adoption. This standard will have the same effective date and transition requirements as ASU 2014-09. Management is currently determining the impact that adoption of this guidance will have on the Company's financial statement results.


2.
STOCK-BASED COMPENSATION PLANS:

Officers and other key employees of SJG participate in the stock-based compensation plans of SJI. Performance-based restricted shares vest over a three-year period and are subject to SJI achieving certain market and earnings-based performance targets which can cause the actual amount of shares that ultimately vest to range from 0% to 200% of the original share units granted.


10


Beginning in 2015, SJI granted time-based shares of restricted stock, one-third of which vest annually over a three-year period and are limited to a 100% payout. Vesting of time-based grants is contingent upon SJI achieving a return on equity (ROE) of at least 7% during the initial year of the grant and meeting the service requirement. Provided that the 7% ROE requirement is met in the initial year, payment is solely contingent upon the service requirement being met in years two and three of the grant. During the six months ended June 30, 2016 and 2015, SJG officers and other key employees were granted 9,819 and 7,912 shares of time-based restricted stock, respectively.

Grants containing market-based performance targets use SJI's total shareholder return (TSR) relative to a peer group to measure performance. As TSR-based grants 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 on a straight-line basis over the requisite three-year 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 TSR-based restricted stock awards on the date of grant is estimated using a Monte Carlo simulation model.

Through 2014, grants containing earnings-based targets were based on SJI's earnings growth rate per share (EGR) relative to a peer group to measure performance. In 2015, earning-based performance targets included pre-defined EGR and return on equity (ROE) goals to measure performance. Beginning in 2016, performance targets include pre-defined compounded earnings annual growth rate (CEGR) for SJI. As EGR-based, ROE-based, and CEGR-based grants are contingent upon performance and service conditions, SJI is required to measure and recognize stock-based compensation expense based on the fair value at the date of grant over the requisite three-year period of each award. The fair value is measured as the market price at the date of grant. The initial accruals of compensation expense are based on the estimated number of shares expected to vest, assuming the requisite service is rendered and probable outcome of the performance condition is achieved. That estimate is revised if subsequent information indicates that the actual number of shares is likely to differ from previous estimates. Compensation expense is ultimately adjusted based on the actual achievement of service and performance targets.

We are allocated a portion of SJI's compensation cost during the vesting period. We accrue a liability and record compensation cost over the requisite three-year service period based on the grant date fair value as described above for each type of grant. 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 plans, 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 June 30, 2016, and the assumptions used to estimate the fair value of the awards:

Grants
 
Shares
Outstanding
 
Fair Value
Per Share
 
Expected
Volatility
 
Risk-Free
Interest Rate
2014 - TSR
 
9,980

 
$
21.31

 
20.0
%
 
0.80
%
2014 - EGR
 
9,980

 
$
27.22

 
n/a

 
n/a

2015 - TSR
 
7,081

 
$
26.31

 
16.0
%
 
1.10
%
2015 - EGR, ROE, Time
 
15,669

 
$
29.47

 
n/a

 
n/a

2016 - TSR
 
11,457

 
$
22.53

 
18.1
%
 
1.31
%
2016 - CEGR, Time
 
21,276

 
$
23.52

 
n/a

 
n/a

 
Expected volatility is based on the actual volatility of SJI’s share price over the preceding three-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 three-year term of the restricted shares. As notional dividend equivalents are credited to the holders during the three-year service period, no reduction to the fair value of the award is required.

The cost for restricted stock awards during the six months ended June 30, 2016 and 2015 is approximately $0.2 million and $0.1 million per quarter, respectively. Of these costs, approximately one half was capitalized to Utility Plant.

As of June 30, 2016, there was $1.1 million of total unrecognized compensation cost related to nonvested share-based compensation awards granted under the plans. That cost is expected to be recognized over a weighted average period of 2.0 years.


11


The following table summarizes information regarding restricted stock award activity during the six months ended June 30, 2016, excluding accrued dividend equivalents:

 
Shares
 
Weighted
Average
Grant Date
Fair Value
Nonvested Shares Outstanding, January 1, 2016
46,475

 
$
26.67

 
 
 
 
Granted
32,732

 
$
23.17

Canceled / Forfeited
(1,154
)
 
$
26.24

   Vested
(2,610
)
 
29.47

 
 
 
 
Nonvested Shares Outstanding, June 30, 2016
75,443

 
$
25.06


Performance targets during the three-year vesting periods were not attained for the January 2012 or 2013 grants that vested at December 31, 2014 and 2015, respectively. As a result, no shares were awarded in 2015 or 2016 associated with those grants. However, the initial performance hurdle for the 2015 time-based grant was met. As a result, 2,610 shares were awarded to Officers and other key employees during the six months ended June 30, 2016 at a market value of $0.1 million. SJG has a policy of making cash payments to SJI to satisfy its obligations under the Plan. Cash payments to SJI during the six months ended June 30, 2016 and 2015 were approximately $0.2 million in each period relating to stock awards. Additionally, a change in control could result in the nonvested shares becoming nonforfeitable or immediately payable in cash.




3.
RATES AND REGULATORY ACTIONS:

SJG is subject to the rules and regulations of the New Jersey Board of Public Utilities (BPU).

In January 2016, SJG provided a Basic Gas Supply Service (BGSS) bill credit of approximately $20.0 million to its residential and small commercial customers. This credit is in addition to an overall rate reduction of 10.3% that was approved by the BPU and took effect in October 2015. SJG’s ability to offer the BGSS bill credit is a direct result of lower wholesale natural gas prices and the overall management of its gas supply portfolio. The BGSS clause serves as a method to pass along increases or decreases in gas costs to customers; therefore, SJG’s income is not affected by BGSS rate adjustments or bill credits.

In February 2016, SJG filed a petition with the BPU for approval to continue its Accelerated Infrastructure Replacement Program (AIRP), which will expire at the end of 2016. In its petition, SJG has requested approval to continue its AIRP for an additional seven years, with program investments totaling approximately $500.0 million, to retire and replace bare steel and cast iron mains, bare steel services, and other aging infrastructure. The petition proposes to recover the costs of, and a return on, future AIRP investments through annual base rate adjustments. The petition also includes a request to reflect in base rates approximately $76.0 million of AIRP investments that will have been made since the conclusion of SJG’s last base rate case in October 2014 through the end of 2016. This petition is currently pending.

Also in February 2016, the BPU approved a $7.9 million revenue decrease to SJG’s Energy Efficiency Tracker (EET), which recovers the cost of, and an allowed return on, investments in Energy Efficiency Programs (EEP). SJG’s original EEPs and its first EEP Extension, approved by the BPU in 2009 and 2013, respectively, ended in July 2013 and August 2015, respectively. The revenue requirements associated with these prior investments decrease over time as they are amortized and recovered. SJG is continuing to make energy efficiency investments under its most recent EEP Extension, which was approved by the BPU in August 2015, and is recovering the costs, and the allowed return on, those investments through the EET.


12


In April 2016, the BPU approved a $2.6 million net decrease, including taxes, in annual revenues collected from SJG customers through the Societal Benefits Clause (SBC) charge and the Transportation Initiation Clause (TIC) charge, comprised of a $5.2 million increase in revenues from the Remediation Adjustment Clause (RAC) component of the SBC, a $7.1 million decrease in revenues from the Clean Energy Program (CLEP) component of the SBC, and a $0.7 million decrease in TIC revenues, effective May 7, 2016. The increase in the RAC is driven by an increase in costs associated with the remediation of former manufactured gas plants. The decrease in the CLEP component of the SBC is primarily related to the accumulation of prior year over-recoveries. The decrease in the TIC is driven by a decrease in costs. The SBC and TIC allow SJG to recover costs associated with certain State-mandated programs. SJG does not earn any profit from these charges.

Also in April 2016, SJG filed a petition requesting to increase annual revenues from base rates by $4.4 million, including taxes, to reflect the roll-in of investments made through June 2016 under its Storm Hardening and Reliability Program (“SHARP”), with rates to become effective on October 1, 2016. This petition is currently pending.

In June 2016, SJG filed its annual BGSS and Conservation Incentive Program (CIP) rate adjustment petition, requesting a $0.6 million net decrease in annual revenues to be implemented on October 1, 2016, comprised of a $47.1 million decrease in BGSS revenues and a $46.5 million increase in CIP revenues, both including taxes. The level of BGSS revenues requested in annual BGSS filings is based on forecasted gas costs and customer usage information for the upcoming BGSS/CIP year, which runs from October to September. SJG’s request for a decrease of BGSS revenues is caused primarily by decreases in forecasted gas commodity costs for the upcoming BGSS/CIP year of October 2016 to September 2017. The level of CIP revenues requested in annual CIP filings is based on historical customer usage information, comparing prior CIP year customer usage to normal customer usage. SJG’s request for an increase in CIP revenues is caused primarily by lower than normal customer usage caused by weather that was 16.4% warmer than normal during the 2015-2016 winter. This petition is currently pending.

Also in June 2016, SJG filed its annual EET rate adjustment petition, requesting a $0.8 million decrease in revenues to continue recovering the costs of, and the allowed return on, prior investments associated with energy efficiency programs (EEPs). The EET rate recovers the forecasted revenue requirements for the upcoming EET year of October 2016 to September 2017. The requested revenue decrease is the result of the investments associated with SJG's original EEPs, approved by the BPU in 2009, and its EEP extension, approved by the BPU in 2013, which ended in July 2013 and August 2015, respectively. The revenue requirements associated with these prior investments decreases over time as they are amortized. This petition is currently pending.

There have been no other significant regulatory actions or changes to SJG's rate structure since December 31, 2015. See Note 3 to the Financial Statements in Item 8 of SJG's Annual Report on Form 10-K for the year ended December 31, 2015.
 


13



4.
REGULATORY ASSETS AND LIABILITIES:

There have been no significant changes to the nature of SJG’s regulatory assets and liabilities since December 31, 2015, which are described in Notes 3 and 4 to the Financial Statements in Item 8 of SJG’s Form 10-K for the year ended December 31, 2015.

Regulatory Assets consisted of the following items (in thousands):
 
June 30, 2016
 
December 31, 2015
Environmental Remediation Costs:
 
 
 
Expended - Net
$
50,650

 
$
42,032

Liability for Future Expenditures
152,349

 
123,194

Deferred Asset Retirement Obligation Costs
42,912

 
42,430

Deferred Pension and Other Postretirement Benefit Costs
79,779

 
79,779

Deferred Gas Costs - Net

 
2,701

Conservation Incentive Program Receivable
21,766

 
2,624

Deferred Interest Rate Contracts (Note 11)
10,363

 
7,631

Energy Efficiency Tracker

 
496

Pipeline Supplier Service Charges
2,943

 
3,776

Pipeline Integrity Cost
4,447

 
4,596

AFUDC - Equity Related Deferrals
11,938

 
11,423

Other Regulatory Assets
3,217

 
2,752

 
 
 
 
Total Regulatory Assets
$
380,364

 
$
323,434


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 Remediation Adjustment Clause (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. The increase from December 31, 2015 is a result of expenditures made during the first six months of 2016 and an increase in the expected future expenditures for remediation activities primarily due to an increase in the scope of the remediation at a site related to additional contamination being discovered.

DEFERRED GAS COSTS - NET - See discussion under "Deferred Revenues - Net" below.

CONSERVATION INCENTIVE PROGRAM (CIP) RECEIVABLE – The CIP tracking mechanism adjusts earnings when actual usage per customer experienced during the period varies from an established baseline usage per customer. Actual usage per customer was less than the established baseline during the 2015 - 2016 winter season and, more notably, during the first six months of 2016, resulting in an increase in the receivable. This is primarily the result of warm weather experienced in the region.



14


Regulatory Liabilities consisted of the following items (in thousands):
 
June 30, 2016
 
December 31, 2015
Excess Plant Removal Costs
$
31,078

 
$
32,644

Deferred Revenues-Net
18,631

 

Societal Benefit Costs
8,233

 
10,197

Energy Efficiency Tracker
2,068

 

 


 


Total Regulatory Liabilities
$
60,010

 
$
42,841


DEFERED REVENUES - NET - Over/under collections of gas costs are monitored through SJG's BGSS mechanism. Net under collected gas costs are classified as a regulatory asset and net over collected gas costs are classified as a regulatory liability. Derivative contracts used to hedge natural gas purchases are also included in the BGSS, subject to BPU approval. The BGSS changed from a $2.7 million regulatory asset at December 31, 2015 to a $18.6 million regulatory liability at June 30, 2016 primarily due to the gas costs recovered from customers exceeding the actual cost of the commodity.

ENERGY EFFICIENCY TRACKER (EET) - This regulatory liability primarily represents energy efficiency measures installed in customer homes and businesses. The change from a $0.5 million regulatory asset at December 31, 2015 to a $2.1 million regulatory liability at June 30, 2016 is due to recoveries being greater than the cost of, and allowed return on, investments in the Energy Efficiency Programs. In February 2016, the BPU approved a $7.9 million revenue decrease to SJG’s EET (see Note 3).



5.
RELATED-PARTY TRANSACTIONS:

There have been no significant changes in the nature of SJG’s related-party transactions since December 31, 2015. See Note 5 to the Financial Statements in Item 8 of SJG’s Annual Report on Form 10-K for the year ended December 31, 2015 for a detailed description of the related parties and their associated transactions.

A summary of related-party transactions, excluding pass-through items, included in Operating Revenues were as follows (in thousands):
 
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2016
 
2015
 
2016
 
2015
Operating Revenues/Affiliates:
 
 
 
 
 
 
 
SJRG
$
421

 
$
479

 
$
4,422

 
$
1,531

Marina
89

 
135

 
206

 
367

Total Operating Revenue/Affiliates
$
510

 
$
614

 
$
4,628

 
$
1,898


Related-party transactions, excluding pass-through items, included in Operating Expenses were as follows (in thousands):
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2016
 
2015
 
2016
 
2015
Costs of Sales/Affiliates (Excluding depreciation)
 
 
 
 
 
 
 
SJRG
$
1,514

 
$
1,508

 
$
9,503

 
$
20,531

Energy-Related Derivative Losses / (Gains) *
 
 
 
 
 
 
 
SJRG
$

 
$
69

 
$

 
$
65


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


15


Operations Expense/Affiliates:
 
 
 
 
 
 
 
SJI
$
5,315

 
$
3,364

 
$
9,870

 
$
7,281

Millennium
701

 
693

 
1,395

 
1,353

Other
(49
)
 
(108
)
 
(106
)
 
(217
)
Total Operations Expense/Affiliates
$
5,967

 
$
3,949

 
$
11,159

 
$
8,417




6.
FINANCIAL INSTRUMENTS:

RESTRICTED INVESTMENTS - In accordance with the terms of our tax-exempt first mortgage bonds, unused proceeds are required to be escrowed pending approved construction expenditures. As of both June 30, 2016 and December 31, 2015, the escrowed proceeds, including interest earned, totaled $32,224. SJG maintains a margin account with a counterparty in conjunction with SJG's risk management activities as detailed in Note 11. The funds provided by SJG will increase or decrease as the number and value of outstanding energy-related contracts held with this counterparty change. As of June 30, 2016, the balance owed to this counterparty totaled $1.8 million and as of December 31, 2015, the balance held with this counterparty totaled $6.7 million. The carrying amounts of the Restricted Investments approximate their fair value at June 30, 2016 and December 31, 2015, which would be included in Level 1 of the fair value hierarchy. (See Note 10 - Fair Value of Financial Assets and Financial Liabilities.)

NOTE RECEIVABLE - In June 2015, SJG advanced $10.0 million to a not-for-profit organization formed to spur economic development in Atlantic City, New Jersey,. The Note bears interest at 1% for an initial term of six months, with the borrower’s option to extend the term for two additional terms of three months each. In December 2015 and February 2016, the borrower exercised each option, respectively. SJG holds a first lien security interest on land in Atlantic City as collateral against this note. The carrying amount of this receivable approximates its fair value at June 30, 2016 and December 31, 2015, which would be included in Level 2 of the fair value hierarchy (See Note 10 - Fair Value of Financial Assets and Financial Liabilities). In July 2016, the note was repaid in full (see Note 15).
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 to ten years with no interest. The carrying amounts of such loans were $11.0 million and $12.9 million as of June 30, 2016 and December 31, 2015, 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 condensed balance sheets. The carrying amounts noted above are net of unamortized discounts resulting from imputed interest in the amount of $1.1 million and $1.3 million as of June 30, 2016 and December 31, 2015, respectively. The annualized amortization to interest is not material to SJG’s financial statements. The carrying amounts of these receivables approximate their fair value at June 30, 2016 and December 31, 2015, which would be included in Level 2 of the fair value hierarchy (See Note 10 - Fair Value of Financial Assets and Financial Liabilities.)
 
FINANCIAL INSTRUMENTS NOT CARRIED AT FAIR VALUE - The fair value of a financial instrument is the market price to sell an asset or transfer a liability at the measurement date. The carrying amounts of SJG's financial instruments approximate their fair values at June 30, 2016 and December 31, 2015, except as noted below.
For Long-Term Debt, in estimating the fair value, we use the present value of remaining cash flows at the balance sheet date. We based the estimates on interest rates available to SJG at the end of each period for debt with similar terms and maturities (Level 2 in the fair value hierarchy. See Note 10 - Fair Value of Financial Assets and Financial Liabilities). The estimated fair values of SJG's long-term debt, including current maturities, as of June 30, 2016 and December 31, 2015, were $733.0 million and $657.4 million, respectively. The carrying amount of SJG's long-term debt, including current maturities, as of June 30, 2016 and December 31, 2015, was $666.7 million and $605.4 million, respectively. The carrying amounts as of June 30, 2016 and December 31, 2015 are net of unamortized debt issuance costs of $6.3 million and $6.6 million, respectively (see Note 1).



16



7.
LINES OF CREDIT:

Credit facilities and available liquidity as of June 30, 2016 were as follows (in thousands):
 
 
Total Facility
 
Usage
 
Available Liquidity
 
Expiration Date
 
Commercial Paper Program/ Revolving Credit Facility
$
200,000

 
$
14,100

(A)
$
185,900

 
May 2018
 
Uncommitted Bank Lines
10,000

 

 
10,000

 
August 2016
(B)
 
 
 
 
 
 
 
 
 
Total
$
210,000

 
$
14,100

(A)
$
195,900

 
 
 

(A) Includes letters of credit outstanding in the amount of $0.8 million.
(B) SJG anticipates renewing the Uncommitted Bank Lines prior to expiration.

The SJG revolving credit facility is provided by a syndicate of banks and contains one financial covenant limiting the ratio of indebtedness to total capitalization (as defined in the credit agreement) to not more than 0.65 to 1 measured at the end of each fiscal quarter. SJG was in compliance with this covenant as of June 30, 2016.

SJG manages 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  have fixed maturities which vary by note, but may not exceed 270 days from the date of issue. Proceeds from the notes are used for general corporate purposes.  SJG uses the commercial paper program in tandem with the $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 six months ended June 30, 2016 and 2015 were $73.7 million and $112.0 million, respectively. The maximum amount outstanding under these credit facilities during the six months ended June 30, 2016 and 2015 were $141.7 million and $139.1 million, respectively.

Borrowings under these credit facilities are at market rates. The weighted average interest rate on these borrowings, which changes daily, was 0.67% and 0.45% at June 30, 2016 and 2015, respectively.



8.
PENSION AND OTHER POSTRETIREMENT BENEFITS:

For the three and six months ended  June 30, 2016 and 2015, net periodic benefit cost related to the employee and officer pension and other postretirement benefit plans consisted of the following components (in thousands):
 
Pension Benefits
 
Pension Benefits
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2016
 
2015
 
2016
 
2015
Service Cost
$
797

 
$
925

 
$
1,784

 
$
1,992

Interest Cost
2,215

 
2,120

 
4,466

 
4,168

Expected Return on Plan Assets
(2,440
)
 
(2,784
)
 
(4,976
)
 
(5,519
)
Amortizations:
 
 
 
 
 
 
 
Prior Service Cost
38

 
40

 
78

 
79

Actuarial Loss
1,729

 
1,995

 
3,460

 
3,959

Net Periodic Benefit Cost
2,339

 
2,296

 
4,812

 
4,679

Capitalized Benefit Cost
(1,213
)
 
(1,194
)
 
(2,400
)
 
(2,433
)
Deferred Benefit Cost
(161
)
 
(325
)
 
(322
)
 
(325
)
Total Net Periodic Benefit Expense
$
965

 
$
777

 
$
2,090

 
$
1,921


17


 
Other Postretirement Benefits
 
Other Postretirement Benefits
 
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
 
2016
 
2015
 
2016
 
2015
 
Service Cost
$
58

 
$
190

 
$
212

 
$
372

 
Interest Cost
216

 
561

 
651

 
991

 
Expected Return on Plan Assets
(256
)
 
(581
)
 
(773
)
 
(997
)
 
Amortizations:

 


 

 

 
Prior Service Cost
(28
)
 
118

 
(86
)
 
202

 
Actuarial Loss
80

 
233

 
276

 
447

 
Net Periodic Benefit Cost
70

 
521

 
280

 
1,015

 
Capitalized Benefit Cost
(45
)
 
(271
)
 
(146
)
 
(528
)
 
Deferred Benefit Cost

 
(79
)
 

 
(79
)
 
Total Net Periodic Benefit Expense
$
25

 
$
171

 
134

 
408

 

Capitalized benefit costs reflected in the table above relate to our construction program. Deferred benefit costs relate to the deferral of incremental expenses associated with the adoption of new mortality tables effective December 31, 2014 and 2015. Deferred benefit costs are expected to be recovered through rates as part of our next base rate case.

SJG contributed $12.0 million to the pension plans in January 2015. No contributions were made to the pension plans during the six-month period ended June 30, 2016. SJG does not expect to make any contributions to the pension plans in 2016; however, changes in future investment performance and discount rates may ultimately result in a contribution. Payments related to the unfunded Supplemental Executive Retirement Plan (SERP) are expected to approximate $2.2 million in 2016. We also have a regulatory obligation to contribute approximately $3.6 million annually to the other postretirement benefit plans’ trusts, less direct costs incurred.

See Note 11 to the Financial Statements in Item 8 of SJG’s Annual Report on Form 10-K for the year ended December 31, 2015 for additional information related to SJG’s pension and other postretirement benefits.


9.    COMMITMENTS AND CONTINGENCIES:

STANDBY LETTER OF CREDIT - SJG provided a $0.8 million letter of credit under its revolving credit facility to support the remediation of environmental conditions at certain locations in our service territory. SJG also provided a $25.2 million letter of credit under a separate facility outside of its revolving credit facility to support variable-rate demand bonds issued through the New Jersey Economic Development Authority (NJEDA) to finance the expansion of SJG’s natural gas distribution system. 

ENVIRONMENTAL REMEDIATION COSTS - SJG incurred and recorded costs for environmental cleanup of 12 sites where SJG or its predecessors operated gas manufacturing plants. SJG stopped manufacturing gas in the 1950s. Other than the changes discussed in Note 4 to the condensed financial statements, there have been no significant changes to the status of SJG’s environmental remediation efforts since December 31, 2015, as described in Note 12 to the Financial Statements in Item 8 of SJG’s Annual Report on Form 10-K for the year ended December 31, 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 date at which any of the primary terms of these contracts expire is October 2017. The transportation and storage agreements entered into between us and each of our interstate pipeline service providers were done in accordance with their respective FERC-approved tariffs. Our cumulative obligation for gas supply-related demand charges and reservation fees paid for these services averages approximately $5.9 million per month and is recovered on a current basis through the BGSS.


18


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 $0.6 million and $0.8 million related to all claims in the aggregate as of June 30, 2016 and December 31, 2015, respectively. Management does not believe that it is reasonably possible that there will 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 that would have a material effect on the Company's financial position, results of operations or cash flows.

COLLECTIVE BARGAINING AGREEMENTS - Unionized personnel represent approximately 60% of our workforce at June 30, 2016. The Company has collective bargaining agreements with two unions who represent these employees: the International Brotherhood of Electrical Workers (IBEW) operates under a collective bargaining agreement that runs through February 2017; and the International Association of Machinists and Aerospace Workers (IAM) operates under a collective bargaining agreement that expires in August 2017.

10.
FAIR VALUE OF FINANCIAL ASSETS AND FINANCIAL LIABILITIES:

GAAP establishes a hierarchy that prioritizes fair value measurements based on the types of inputs used for the various valuation techniques.  The levels of the hierarchy are described below:

Level 1:  Observable inputs, such as quoted prices in active markets for identical assets or liabilities.

Level 2:  Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly; these include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active.

Level 3:  Unobservable inputs that reflect the reporting entity’s own assumptions.

Assessment of the significance of a particular input to the fair value measurement requires judgment and may affect the valuation of financial assets and financial liabilities and their placement within the fair value hierarchy.

For financial assets and financial liabilities measured at fair value on a recurring basis, information about the fair value measurements for each major category is as follows (in thousands):

As of June 30, 2016
 
 
 
 
 
 
 
 
Total
 
Level 1
 
Level 2
 
Level 3
Assets
 
 
 
 
 
 
 
Available-for-Sale Securities (A)
$
8,996

 
$
1,757

 
$
7,239

 
$

Derivatives – Energy Related Assets (B)
4,127

 
4,123

 
3

 
1

 
$
13,123

 
$
5,880

 
$
7,242

 
$
1

 
 
 
 
 
 
 
 
Liabilities
 

 
 

 
 

 
 

 
 
 
 
 
 
 
 
Derivatives – Energy Related Liabilities (B)
$
4,697

 
$
933

 
$
3,539

 
$
225

Derivatives – Other (C)
10,363

 


 
10,363

 

 
$
15,060

 
$
933

 
$
13,902

 
$
225



19


As of December 31, 2015
 
 
 
 
 
 
 
 
Total
 
Level 1
 
Level 2
 
Level 3
Assets
 
 
 
 
 
 
 
Available-for-Sale Securities (A)
$
8,788

 
$
1,722

 
$
7,066

 
$

Derivatives - Energy Related Assets (B)
1,141

 
398

 
144

 
599

 
$
9,929

 
$
2,120

 
$
7,210

 
$
599

 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives - Energy Related Liabilities (B)
$
5,840

 
$
5,424

 
$

 
$
416

Derivatives - Other (C)
7,631

 

 
7,631

 

 
$
13,471

 
$
5,424

 
$
7,631

 
$
416


(A)  Available-for-Sale Securities include securities that are traded in active markets and securities that are not traded publicly. The securities traded in active markets are valued using the quoted principal market close prices that are provided by the trustees and are categorized in Level 1 in the fair value hierarchy. The remaining securities consist of funds that are not publicly traded. These funds, which consist of stocks and bonds that are traded individually in active markets, are valued using quoted prices for similar assets and are categorized in Level 2 in the fair value hierarchy.

(B)  Derivatives – Energy Related Assets and Liabilities are traded in both exchange-based and non-exchange-based markets. Exchange-based contracts are valued using unadjusted quoted market sources in active markets and are categorized in Level 1 in the fair value hierarchy. Certain non-exchange-based contracts are valued using indicative price quotations available through brokers or over-the-counter, on-line exchanges and are categorized in Level 2. These price quotations reflect the average of the bid-ask mid-point prices and are obtained from sources that management believes provide the most liquid market. 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 as the model inputs generally are not observable.

Significant Unobservable Inputs - Management uses the discounted cash flow model to value Level 3 physical and financial forward contracts, which calculates mark-to-market valuations based on forward market prices, original transaction prices, volumes, risk-free rate of return and credit spreads. Inputs to the valuation model are reviewed and revised as needed, based on historical information, updated market data, market liquidity and relationships, and changes in third party pricing sources. The validity of the mark-to-market valuations and changes in mark-to-market valuations from period to period are examined and qualified against historical expectations by the risk management function. If any discrepancies are identified during this process, the mark-to-market valuations or the market pricing information is evaluated further and adjusted, if necessary.

Level 3 valuation methods for natural gas derivative contracts include utilizing another location in close proximity adjusted for certain pipeline charges to derive a basis value. The significant unobservable inputs used in the fair value measurement of certain natural gas contracts consist of forward prices developed based on industry-standard methodologies. Significant increases (decreases) in these forward prices for purchases of natural gas would result in a directionally similar impact to the fair value measurement and for sales of natural gas would result in a directionally opposite impact to the fair value measurement.

(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.


20


The following table provides quantitative information regarding significant unobservable inputs in Level 3 fair value measurements (in thousands):

Type
Fair Value at June 30, 2016
Valuation Technique
Significant Unobservable Input
Range
[Weighted Average]
 
 
Assets
Liabilities
 
 
 
 
Forward Contract - Natural Gas
$1
$225
Discounted Cash Flow
Forward price (per dt)

$1.84 - $6.16
[$4.38]
(A)
 
 
 
 
 
 
 

Type
Fair Value at December 31, 2015
Valuation Technique
Significant Unobservable Input
Range
[Weighted Average]
 
 
Assets
Liabilities
 
 
 
 
Forward Contract - Natural Gas
$599
$416
Discounted Cash Flow
Forward price (per dt)

$1.18 - $5.21
[$2.90]
(A)
 
 
 
 
 
 
 

(A) Represents the range, along with the weighted average, of forward prices for the sale and purchase of natural gas.

The changes in fair value measurements of Derivatives - Energy Related Assets and Liabilities for the three and six months ended June 30, 2016, using significant unobservable inputs (Level 3), are as follows (in thousands):
 
Three Months
Ended
June 30, 2016
 
Six Months Ended
June 30, 2016
Balance at beginning of period
$
(4
)
 
$
183

Other Changes in Fair Value from Continuing and New Contracts, Net
(220
)
 
(224
)
Settlements

 
(183
)
 
 
 
 
Balance at end of period
(224
)
 
(224
)


The changes in fair value measurements of Derivatives - Energy Related Assets and Liabilities for the three and six months ended June 30, 2015, using significant unobservable inputs (Level 3), are as follows (in thousands):
 
Three Months
Ended
June 30, 2015
 
Six Months Ended
June 30, 2015
Balance at beginning of period
$

 
$

Other Changes in Fair Value from Continuing and New Contracts, Net
(584
)
 
(584
)
 
 
 
 
Balance at end of period
(584
)
 
(584
)



21



11. DERIVATIVE INSTRUMENTS:

SJG is involved in buying, selling, transporting and storing natural gas and is subject to market risk on expected future purchases and sales due to commodity price fluctuations. The Company, through a counterparty, uses a variety of derivative instruments to limit this exposure to market risk in accordance with strict corporate guidelines. These derivative instruments include forward contracts, futures contracts, swap agreements and options contracts. As of June 30, 2016, SJG had outstanding derivative contracts intended to limit the exposure to market risk on 10.4 million decatherms (MMdts) of expected future purchases of natural gas and 1.1 MMdts of expected future sales of natural gas. In addition to these derivative contracts, SJG had basis and index related purchase contracts of 2.4 MMdts and sales contracts of 7.4 MMdts for net contracted volumes of 5.0 MMdts. These contracts, which do not qualify for the normal purchase and sale exemption and have not been designated as hedging instruments under GAAP, are measured at fair value and recorded in Derivatives — Energy Related Assets or Derivatives — Energy Related Liabilities on the condensed balance sheets. The costs or benefits of these short-term contracts are recoverable through SJG’s BGSS clause, subject to BPU approval. As a result, the net unrealized pre-tax gains and losses for these energy-related commodity contracts are included with realized gains and losses in Regulatory Assets or Regulatory Liabilities on the condensed balance sheets. As of June 30, 2016 and December 31, 2015, SJG had $0.6 million and $4.7 million of unrealized gains, respectively, included in its BGSS related to open financial contracts.

The Company has also entered into interest rate derivatives to hedge exposure to increasing interest rates and the impact of those rates on cash flows of variable-rate debt. These interest rate derivatives, which have not been designated as hedging instruments under GAAP, are measured at fair value and recorded in Derivatives-Other on the condensed balance sheets. The fair value represents the amount SJG would have to pay the counterparty to terminate these contracts as of those dates. There have been no significant changes to the Company’s active interest rate swaps since December 31, 2015, which are described in Note 1 to the Financial Statements in Item 8 of SJG’s Annual Report on Form 10-K for the year ended December 31, 2015. Subject to BPU approval, the market value upon termination of these interest rate derivatives can be recovered in rates and, therefore, these unrealized losses have been included in Regulatory Assets on the condensed balance sheets.

We previously used derivative transactions known as “Treasury Locks” to hedge against the impact on our cash flows of possible interest rate increases on debt issued in September 2005. The initial $1.4 million cost of the Treasury Locks has been included in Accumulated Other Comprehensive Loss and is being amortized over the 30-year life of the associated debt issue. As of both June 30, 2016 and December 31, 2015, the unamortized balance was approximately $0.9 million.
.
The fair values of all derivative instruments, as reflected in the condensed balance sheets as of June 30, 2016 and December 31, 2015, are as follows (in thousands):

Derivatives not designated as hedging instruments under GAAP
 
June 30, 2016
 
December 31, 2015
 
 
Assets
 
Liabilities
 
Assets
 
Liabilities
Energy related commodity contracts:
 
 
 
 
 
 
 
 
Derivatives – Energy Related – Current
 
$
3,573

 
$
4,694

 
$
1,077

 
$
5,489

Derivatives – Energy Related – Non-Current
 
554

 
3

 
64

 
351

Interest rate contracts:
 
 
 
 
 
 
 
 
Derivatives – Other Current
 

 
529

 

 

Derivatives – Other Noncurrent
 

 
9,834

 


 
7,631

Total derivatives not designated as hedging instruments under GAAP
 
4,127

 
15,060

 
1,141

 
13,471

Total Derivatives
 
$
4,127

 
$
15,060

 
$
1,141

 
$
13,471

 

The Company enters into derivative contracts with counterparties, some of which are subject to master netting arrangements, which allow net settlements under certain conditions. The Company presents derivatives at gross fair values on the condensed balance sheets.


22


As of June 30, 2016, and December 31, 2015, information related to these offsetting arrangements were as follows (in thousands):

As of June 30, 2016:
 
 
 
 
 
 
 
 
 
 
 
 
Description
 
Gross amounts of recognized assets/liabilities
 
Gross amount offset in the balance sheet
 
Net amounts of assets/liabilities in balance sheet
 
Gross amounts not offset in the balance sheet
 
Net amount
 
 
 
 
Financial Instruments
 
Cash Collateral Posted
 
Derivatives - Energy Related Assets
 
$
4,127

 
$

 
$
4,127

 
$
(933
)
(A)
$
(1,801
)
 
$
1,393

Derivatives - Energy Related Liabilities
 
(4,697
)
 

 
(4,697
)
 
933

(B)

 
(3,764
)
Derivatives - Other
 
(10,363
)
 

 
(10,363
)
 

 

 
(10,363
)

As of December 31, 2015:
 
 
 
 
 
 
 
 
 
 
 
 
Description
 
Gross amounts of recognized assets/liabilities
 
Gross amount offset in the balance sheet
 
Net amounts of assets/liabilities in balance sheet
 
Gross amounts not offset in the balance sheet
 
Net amount
 
 
 
 
Financial Instruments
 
Cash Collateral Posted
 
Derivatives - Energy Related Assets
 
$
1,141

 
$

 
$
1,141

 
$
(399
)
(A)
$

 
$
742

Derivatives - Energy Related Liabilities
 
(5,840
)
 

 
(5,840
)
 
399

(B)
5,025

 
(416
)
Derivatives - Other
 
(7,631
)
 

 
(7,631
)
 

 

 
(7,631
)

(A) The balances at June 30, 2016 and December 31, 2015 were related to derivative liabilities which can be net settled against derivative assets.

(B) The balances at June 30, 2016 and December 31, 2015 were related to derivative assets which can be net settled against derivative liabilities.

The effect of derivative instruments on the condensed statements of income for the three and six months ended June 30, 2016 and 2015 are as follows (in thousands):
 
 
Three months ended
June 30,
 
Six months ended
June 30,
Derivatives in Cash Flow Hedging Relationships
 
2016
 
2015
 
2016
 
2015
Interest Rate Contracts:
 
 
 
 
 
 
 
 
Losses reclassified from Accumulated Other Comprehensive Loss into income (a)
 
$
(12
)
 
$
(12
)
 
$
(24
)
 
$
(24
)
(a) Included in Interest Charges

Net realized loss of $1.6 million and $2.1 million associated with SJG's energy-related financial commodity contracts for the three months ended June 30, 2016 and 2015, and loss of $4.4 million and $4.8 million for the six months ended June 30, 2016 and 2015, 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, as applicable, and there is no impact to earnings.


23



12.
LONG-TERM DEBT:

In January 2016, SJG issued $61.0 million of long-term debt at 1.37% under a $200.0 million aggregate syndicated bank term facility. The facility is now fully drawn. The total outstanding amount under this facility as of June 30, 2016 was $200.0 million, which was reclassified to current portion of long-term debt on the condensed balance sheets as it is due within one year. SJG is evaluating alternatives, including refinancing or renewing the facility.

The Company did not retire any long-term debt during the six months ended June 30, 2016. We retire debt when it is cost effective as permitted by the debt agreements.  


13.    ACCUMULATED OTHER COMPREHENSIVE LOSS:

The changes in Accumulated Other Comprehensive Loss (AOCL) for the three and six months ended June 30, 2016 are as follows (in thousands):
 
 
 
 
 
 
 
 
 
Postretirement Liability Adjustment
 
Unrealized Gain (Loss) on Derivatives-Other
 
Unrealized Gain (Loss) on Available-for-Sale Securities
 
Total
Balance at April 1, 2016 (a)
$
(12,220
)
 
$
(537
)
 
$
(94
)
 
$
(12,851
)
Other comprehensive loss before reclassifications

 

 
73

 
73

   Amounts reclassified from AOCL (b)

 
7

 
(70
)
 
(63
)
Net current period other comprehensive income

 
7

 
3

 
10

Balance at June 30, 2016 (a)
$
(12,220
)
 
$
(530
)
 
$
(91
)
 
$
(12,841
)
 
 
 
 
 
 
 
 
 
Postretirement Liability Adjustment
 
Unrealized Gain (Loss) on Derivatives-Other
 
Unrealized Gain (Loss) on Available-for-Sale Securities
 
Total
Balance at January 1, 2016 (a)
$
(12,220
)
 
$
(544
)
 
$
(98
)
 
$
(12,862
)
Other comprehensive loss before reclassifications

 

 
136

 
136

   Amounts reclassified from AOCL (b)

 
14

 
(129
)
 
(115
)
Net current period other comprehensive income (loss)

 
14

 
7

 
21

Balance at June 30, 2016 (a)
$
(12,220
)
 
$
(530
)
 
$
(91
)
 
$
(12,841
)

(a) Determined using a combined average statutory tax rate of 40%.
(b) See table below.


24


The reclassifications out of AOCL during the three and six months ended June 30, 2016 are as follows (in thousands):
Components of AOCL
 
Amounts Reclassified from AOCL
 
Affected Line Item in the Condensed Statements of Income
 
Three Months Ended
June 30, 2016
 
Six
Months Ended
June 30, 2016
 
Unrealized Loss in on Derivatives - Other - Interest Rate Contracts designated as cash flow hedges
 
$
12

 
$
24

 
Interest Charges
Income Taxes
 
(5
)
 
(10
)
 
Income Taxes (a)
 
 
$
7

 
$
14

 
 
 
 
 
 
 
 
 
Unrealized Gain on Available-for-Sale Securities
 
$
(117
)
 
$
(216
)
 
Other Income & Expense
Income Taxes
 
47

 
87

 
Income Taxes (a)
 
 
$
(70
)
 
$
(129
)
 
 
 
 
 
 
 
 
 
Gains from reclassifications for the period net of tax
 
$
(63
)
 
$
(115
)
 
 

(a) Determined using a combined average statutory tax rate of 40%.


14.    OTHER PAID IN CAPITAL:

In June 2016, SJG received an equity infusion of $65.0 million from SJI.



15.    SUBSEQUENT EVENT:

In July 2016, the $10.0 million note receivable as of June 30, 2016 from a not-for-profit organization formed to spur economic development in Atlantic City, New Jersey (see Note 6), was repaid in full, including interest.



25



Item 2. Management’s Discussion and Analysis
of Financial Condition and Results of Operations

OVERVIEW:

Organization - We are an operating public utility company engaged in the purchase, transmission and sale of natural gas for residential, commercial and industrial use. We also sell natural gas and pipeline transportation capacity (off-system sales) on a wholesale basis to various customers on the interstate pipeline system and transport natural gas purchased directly from producers or suppliers to their customers. We served 374,818 customers at June 30, 2016 compared with 369,888 customers at June 30, 2015.

Forward-Looking Statements and Risk Factors - This Quarterly Report, including information incorporated by reference, contains forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995.
All statements other than statements of historical fact, including statements regarding future results of operations or financial position, expected sources of incremental margin, strategy, financing needs, future capital expenditures and the outcome or effect of ongoing litigation, are forward-looking. This Quarterly Report uses words such as “anticipate,” “believe,” “expect,” “estimate,” “forecast,” “goal,” “intend,” “objective,” “plan,” “project,” “seek,” “strategy,”"target," “will” and similar expressions to identify forward-looking statements. These forward-looking statements are based on the beliefs and assumptions of management at the time that these statements were made and are inherently uncertain. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those expressed in the forward-looking statements. These risks and uncertainties include, but are not limited to, general economic conditions on an international, national, state and local level; weather conditions in SJG’s marketing areas; changes in commodity costs; changes in the availability of natural gas; “non-routine” or “extraordinary” disruptions in SJG’s distribution system; regulatory, legislative and court decisions; competition; the availability and cost of capital; costs and effects of legal proceedings and environmental liabilities; the failure of customers, suppliers or business partners to fulfill their contractual obligations; and changes in business strategies.

These risks and uncertainties, as well as other risks and uncertainties that could cause actual results to differ materially from those expressed in the forward-looking statements, are described in greater detail under the heading “Item 1A. Risk factors” in this Quarterly Report and in SJG’s Annual Report on Form 10-K for the year ended December 31, 2015 and in any other SEC filings incorporated by reference into this Quarterly Report. No assurance can be given that any goal or plan set forth in any forward-looking statement can or will be achieved, and readers are cautioned not to place undue reliance on such statements, which speak only as of the date they are made. SJG undertakes no obligation to revise or update any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.
 
Critical Accounting Policies - Estimates and Assumptions - Management must make estimates and assumptions that affect the amounts reported in the condensed financial statements and related disclosures. Actual results could differ from those estimates. Five types of transactions presented in our condensed financial statements require a significant amount of judgment and estimation. These relate to regulatory accounting, derivatives, environmental remediation costs, pension and other postretirement benefit costs, and revenue recognition. A discussion of these estimates and assumptions may be found in SJG’s Annual Report on Form 10-K for the year ended December 31, 2015.

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

Regulatory Actions Other than the changes discussed in Note 3 to the condensed financial statements, there have been no significant regulatory actions since December 31, 2015. See detailed discussions concerning regulatory actions in Note 3 to the Financial Statements in item 8 of SJG’s Annual Report on Form 10-K for the year ended December 31, 2015.

Environmental Remediation Other than the changes discussed in Note 4 to the condensed financial statements,there have been no significant changes to the status of SJG’s environmental remediation efforts since December 31, 2015. See detailed discussion concerning environmental remediation costs in Note 12 to the Financial Statements in Item 8 of SJG’s Annual Report on Form 10-K for the year ended December 31, 2015.

Competition - See detailed discussion concerning competition in SJG’s Annual Report on Form 10-K for the year ended December 31, 2015.


26


Customer Choice Legislation - All residential natural gas customers in New Jersey can choose their natural gas commodity supplier under the terms of the “Electric Discount and Energy Competition Act of 1999.” This bill created the framework and necessary time schedules for the restructuring of the state’s electric and natural gas utilities. The Act established unbundling, under which redesigned utility rate structures allow natural gas and electric consumers to choose their energy supplier. Customers purchasing natural gas from a provider other than the local utility (marketer) are charged for the gas costs by the marketer and charged for the transportation costs by the utility. The number of customers purchasing their natural gas from marketers was 34,049 and 36,139 at June 30, 2016 and 2015, respectively.


RESULTS OF OPERATIONS:

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

 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2016
 
2015
 
2016
 
2015
Utility Throughput – decatherms(dt):
 
 
 
 
 
 
 
Firm Sales -
 
 
 
 
 
 
 
Residential
3,032

 
2,535

 
14,170

 
17,289

Commercial
904

 
673

 
3,087

 
4,351

Industrial
56

 
37

 
208

 
265

Cogeneration & Electric Generation
503

 
402

 
697

 
496

Firm Transportation -
 
 
 
 
 
 
 
Residential
268

 
265

 
1,276

 
1,792

Commercial
1,438

 
967

 
4,261

 
4,372

Industrial
2,931

 
3,069

 
5,984

 
6,017

Cogeneration & Electric Generation
1,361

 
1,710

 
2,840

 
3,078

 
 
 
 
 
 
 
 
Total Firm Throughput
10,493

 
9,658

 
32,523

 
37,660

 
 
 
 
 
 
 
 
Interruptible Sales

 
17

 
2

 
20

Interruptible Transportation
225

 
319

 
600

 
652

Off-System Sales
2,722

 
2,157

 
7,772

 
6,621

Capacity Release
17,747

 
13,945

 
33,898

 
28,990

 
 
 
 
 
 
 
 
Total Throughput - Utility
31,187

 
26,096

 
74,795

 
73,943


27


 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2016
 
2015
 
2016
 
2015
Utility Operating Revenues:
 
 
 
 
 
 
 
Firm Sales -
 
 
 
 
 
 
 
Residential
$
34,716

 
$
42,376

 
$
152,498

 
$
212,585

Commercial
8,580

 
9,701

 
30,725

 
47,110

Industrial
431

 
435

 
1,809

 
3,122

Cogeneration & Electric Generation
1,435

 
1,483

 
2,181

 
2,288

Firm Transportation -
 
 
 
 
 
 
 
Residential
2,138

 
2,350

 
8,631

 
10,827

Commercial
6,107

 
4,716

 
18,585

 
18,477

Industrial
4,888

 
5,269

 
10,218

 
11,600

Cogeneration & Electric Generation
863

 
1,088

 
2,372

 
2,996

 
 
 
 
 
 
 
 
Total Firm Revenues
59,158

 
67,418

 
227,019

 
309,005

 
 
 
 
 
 
 
 
Interruptible Sales

 
242

 
18

 
298

Interruptible Transportation
155

 
354

 
487

 
764

Off-System Sales
7,590

 
6,108

 
21,078

 
30,096

Capacity Release
1,566

 
1,350

 
7,381

 
2,658

Other
293

 
340

 
545

 
649

Total Utility Operating Revenues
68,762

 
75,812

 
256,528

 
343,470

 
 
 
 
 
 
 
 
Less:
 

 
 

 
 

 
 

Cost of Sales (Excluding depreciation)
19,997

 
25,419

 
89,300

 
171,521

Conservation Recoveries*
2,032

 
4,861

 
7,133

 
17,124

RAC Recoveries*
2,297

 
2,280

 
4,595

 
4,561

EET Recoveries*
709

 
998

 
1,508

 
2,047

Revenue Taxes
177

 
208

 
538

 
787

Utility Margin**
$
43,550

 
$
42,046

 
$
153,454

 
$
147,430

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Margin:
 

 
 

 
 

 
 

Residential
$
26,483

 
$
23,419

 
$
97,761

 
$
114,103

Commercial and Industrial
14,795

 
12,268

 
40,024

 
44,982

Cogeneration and Electric Generation
1,156

 
1,187

 
2,469

 
2,380

Interruptible
21

 
29

 
42