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EX-32.2 - EXHIBIT 32.2 - SOUTH JERSEY GAS Cosjg-123116ex322.htm
EX-32.1 - EXHIBIT 32.1 - SOUTH JERSEY GAS Cosjg-123116ex321.htm
EX-31.2 - EXHIBIT 31.2 - SOUTH JERSEY GAS Cosjg-123116ex312.htm
EX-31.1 - EXHIBIT 31.1 - SOUTH JERSEY GAS Cosjg-123116ex311.htm
EX-12 - EXHIBIT 12 - SOUTH JERSEY GAS Cosjg-123116exh12.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-K
x
ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2016
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, New Jersey 08037
(Address of principal executive offices, including zip code)
(609) 561-9000
(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act:    Yes o      No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Act:  Yes o No x

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 (§232.405 of this chapter) 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
 
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

All of the equity securities of the registrant are owned by South Jersey Industries, Inc., its parent company, an Exchange Act reporting company named in the registrant's description of its business, which has itself fulfilled its Exchange Act filing requirements.
 
The registrant meets all of the conditions set forth in General Instruction I(1)(a) and (b) of Form 10-K and is therefore filing this form with the reduced disclosure format.

Documents Incorporated by Reference:   None



TABLE OF CONTENTS

 
 
Page No.
 
 
 
 
 
 
 
PART I
 
 
 
 
 
 
 
 
PART II
 
 
 
 
 
 
 
 
PART III
 
 
 
 
 
 
 
 
PART IV
 
 
 
 
 
 
 



  

2


Forward Looking Statements

Certain statements contained in this Annual Report on Form 10-K may qualify as “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements in this Report 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, should be considered forward-looking statements made in good faith by South Jersey Gas Company (SJG or the Company) and are intended to qualify for the safe harbor from liability established by the Private Securities Litigation Reform Act of 1995. When used in this Report, or any other of the Company’s documents or oral presentations, words such as “anticipate,” “believe,” “estimate,” “expect,” “forecast,” “goal,” “intend,” “objective,” “plan,” “project,” “seek,” “strategy,” "target," "will" and similar expressions are intended 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. Such forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those expressed or implied in the forward-looking statements. These risks and uncertainties include, but are not limited to the risks set forth under “Risk Factors” in Part I, Item 1A of this Report and elsewhere throughout this Report. These cautionary statements should not be construed by you to be exhaustive and they are made only as of the date of this Report. While the Company believes these forward-looking statements to be reasonable, there can be no assurance that they will approximate actual experience or that the expectations derived from them will be realized. Further, SJG undertakes no obligation to update or revise any of its forward-looking statements whether as a result of new information, future events or otherwise.

Available Information - Information regarding SJG can be found at the South Jersey Industries, Inc. (SJI) internet address, www.sjindustries.com. We make available free of charge on or through SJI's website SJG’s annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission (SEC). The SEC maintains an Internet site that contains these reports at http://www.sec.gov. The content on any web site referred to in this filing is not incorporated by reference into this filing unless expressly noted otherwise.



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PART I

Item 1. Business

Units of Measurement
 
For Natural Gas:
1 dt
 = One decatherm
1 MMdt
 = One million decatherms
Dts/d
 = Decatherms per day
MDWQ
 = Maximum daily withdrawal quantity
Description of Business

South Jersey Gas Company (SJG) is a regulated natural gas utility. SJG distributes natural gas in the seven southernmost counties of New Jersey.

Additional information on the nature of our business is incorporated by reference to “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Market Risk” and Note 3 to the financial statements.
 
Financial Information About Reportable Segments

Not applicable.
 
Rates and Regulation

Information on our rates and regulatory affairs is incorporated by reference to “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Note 3 to the financial statements.

Sources and Availability of Raw Materials

Transportation and Storage Agreements
 
SJG has direct connections to the interstate pipeline systems of both Transcontinental Gas Pipe Line Company, LLC (Transco) and Columbia Gas Transmission, LLC (Columbia). During 2016, SJG purchased and had delivered approximately 46.5 MMdts of natural gas for distribution to both on-system and off-system customers and for injections into storage. Of this total, 25.1 MMdts were transported on the Transco pipeline system while 21.4 MMdts were transported on the Columbia pipeline system. Moreover, during 2016 third-party suppliers delivered 29.6 MMdts to SJG's system on behalf of end use customers behind our city gate stations. SJG also secures other long-term services from Dominion Transmission, Inc. (Dominion), a pipeline upstream of the Transco and Columbia systems. Services provided by Dominion are utilized to deliver gas into either the Transco or Columbia systems for ultimate delivery to SJG. Services provided by all of the above-mentioned pipelines are subject to the jurisdiction of the Federal Energy Regulatory Commission (FERC). Unless otherwise indicated, our intentions are to renew or extend these service agreements before they expire.

Transco:

Transco is SJG’s largest supplier of long-term gas transmission services which includes both year-round and seasonal firm transportation (FT) service arrangements. When combined, these FT services enable SJG to purchase gas from third parties and have delivered to its city gate stations by Transco a total of 297,958 dts per day (dts/d). Of this total, 133,917 dts/d is long-haul FT (where gas can be transported from the production areas of the Southwest to the market areas of the Northeast) while 164,041 dts/d is market area FT. The terms of SJG’s year-round agreements with Transco extend for various periods through 2025. Certain of these agreements are currently operating under their respective evergreen provisions.


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Of the 297,958 dts/d of Transco services mentioned above, SJG has released a total of 10,000 dts/d of its long-haul and 20,000 dts/d of its market area FT service. These releases were made in association with SJG’s Conservation Incentive Program (CIP) discussed further under Item 7, "Management’s Discussion and Analysis of Financial Condition and Results of Operations." In addition, SJG released a total of 50,000 dts/d of its long-haul FT as part of Asset Management Agreements (AMA). The AMA-related releases are discussed below under “Gas Supplies.” In addition, SJG released a total of 27,500 dts/d of its market area FT as Off-System Sales capacity releases.

SJG currently has six long-term gas storage service agreements with Transco that, when combined, are capable of storing approximately 5.0 MMdts. Through these agreements, SJG can inject gas into market and production area storages during periods of low demand and extract gas at a Maximum Daily Withdrawal Quantity (MDWQ) of up to 107,407 dts during periods of high demand. The longest term of these storage service agreements extends through March 31, 2023.

Dominion:

SJG subscribes to a firm storage service from Dominion, under its Rate Schedule GSS. This storage has an MDWQ of 10,000 dts during the period between November 16 and March 31 of each winter season, with an associated total storage capacity of 423,000 dts. Gas withdrawn from Dominion GSS storage is delivered through both the Dominion and Transco (Leidy Line) pipeline systems for delivery to SJG service territory. The primary term of this agreement extends through March 31, 2019.

Columbia:

SJG subscribes to four firm transportation agreements with Columbia which currently provide for an aggregate of 114,022 dts/d. The term of 9,000 dts/d of this capacity extends through October 31, 2022; the term of 45,022 dts/d extends through October 31, 2019; and the remaining 60,000 dts/d extends through October 31, 2030. SJG released 8,671 dts/d of the total amount to South Jersey Resources Group, LLC (SJRG), an affiliate by common ownership, in conjunction with its CIP. In addition, SJG released a total of 20,000 dts/d of this capacity to two gas marketers at 10,000 dts/d each, one of which is SJRG, leaving a net total of 85,351 dts/d available to SJG. These AMA-related releases are further discussed below under “Gas Supplies.” Moreover, SJG released a total of 18,543 dts/d of its Columbia FT as Off-System Sales capacity releases.

SJG also subscribes to a firm storage service with Columbia under its Rate Schedule FSS along with an associated firm transportation service under Rate Schedule SST, each of which extends through October 31, 2019. SJG has a total FSS MDWQ of 52,891 dts and a related 3,473,022 dts of storage capacity. SJG released to SJRG 19,029 dts/d of its FSS MDWQ along with 1,249,485 dts of its FSS storage capacity. Additionally, SJG released to SJRG 19,029 dts/d of its associated Columbia SST transportation service. Both releases made by SJG were in connection with its CIP and extend through September 30, 2018.

Gas Supplies

During 2016, SJG entered into an AMA with a gas marketer which extends through March 31, 2017. Under this agreement, SJG released to the marketer its firm transportation rights equal to 30,000 dts/d of transportation capacity on Transco. The marketer manages this capacity and provides SJG with up to 30,000 dts/d of firm deliverability each day through March 31, 2017. The marketer's intent was to optimize the capacity released to them under this AMA and pay SJG an asset management fee.

Also in 2016, SJG entered into an additional AMA with a separate gas marketer which extends through October 31, 2017. Under this agreement, SJG has released to the marketer firm transportation rights equal to 10,000 dts/d of transportation capacity on Transco. The marketer manages its capacity and provides SJG with up to 10,000 dts/d of firm deliverability everyday through October 31, 2017. The marketer will seek to optimize the capacity released to it under this AMA and pay SJG an asset management fee.

Also in 2016, SJG entered into two further AMA's with two separate gas marketers which both also extend through October 31, 2017. Under these agreements, SJG has released to each of the marketers firm transportation rights equal to 10,000 dts/d of transportation capacity on Columbia. The marketers manage their respective capacity and each provides SJG with up to 10,000 dts/d of firm deliverability everyday through either March 31 or October 31, 2017, depending on the particular agreement. The marketers will seek to optimize the capacity released to them under these AMA's and pay SJG an asset management fee.

In 2011, SJG entered into a long-term gas purchase agreement with a gas producer, the primary term of which extends through October 31, 2019. The maximum daily quantities (MDQ) available for purchase under this agreement initially start at 6,250 dts/d and ratchet up to an MDQ of 25,000 dts/d. Gas purchased from this producer will be sourced in the Appalachian supply areas and delivered into the Columbia pipeline system for delivery to SJG.


5


As part of its gas purchasing strategy, SJG uses financial contracts to hedge against forward price risk. These contracts are recoverable through SJG’s Basic Gas Supply Service Clause (BGSS), subject to the New Jersey Board of Public Utilities (BPU) approval.

Supplemental Gas Supplies
    
During 2016, SJG entered into a Liquefied Natural Gas (LNG) purchase agreement with a third party LNG supplier. This LNG was made available as a supply source to replenish SJG's LNG inventory at its storage facility, located in McKee City, NJ.

SJG operates peaking facilities which liquefies, stores and vaporizes LNG for injection into its distribution system. SJG’s LNG facility has a storage capacity equivalent to 434,300 dts of natural gas and has an installed capacity to vaporize up to 118,250 dts of LNG per day for injection into its distribution system.

Peak-Day Supply

SJG plans for a winter season peak-day demand on the basis of an average daily temperature of 2 degrees Fahrenheit (F). Gas demand on such a design day for the 2016-2017 winter season is estimated to be 512,891 dts (excluding industrial customers). SJG projects that it has adequate supplies and interstate pipeline entitlements to meet its design day requirements. SJG experienced its highest peak-day demand for calendar year 2016 of 473,178 dts (including industrial customers) on February 13, while experiencing an average temperature of 20.6 degrees F that day.

Natural Gas Prices

SJG’s average cost of natural gas purchased and delivered in 2016, 2015, and 2014, including demand charges, was $3.40 per dt, $4.71 per dt, and $6.56 per dt, respectively.

Patents and Franchises
 
SJG holds nonexclusive franchises granted by municipalities in the seven-county area of southern New Jersey that it serves. No other natural gas public utility presently serves the territory covered by SJG’s franchises. Otherwise, patents, trademarks, licenses, franchises and concessions are not material to the business of SJG.

Seasonal Aspects

SJG experiences seasonal fluctuations in sales when selling natural gas for heating purposes. SJG meets this seasonal fluctuation in demand from its firm customers by buying and storing gas during the summer months, and by drawing from storage and purchasing supplemental supplies during the heating season. As a result of this seasonality, SJG’s revenues and net income are significantly higher during the first and fourth quarters than during the second and third quarters of the year.

Working Capital Practices

Reference is made to “Liquidity and Capital Resources” included in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” of this Report.

Customers

No material part of SJG’s business is dependent upon a single customer or a few customers, the loss of which would be expected to have a material adverse effect on SJG’s business.

Backlog

Backlog is not material to an understanding of SJG’s business.

Government Contracts

No material portion of SJG’s business is subject to renegotiation of profits or termination of contracts or subcontracts at the election of any government.


6


Competition

Information on competition is incorporated by reference to Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations, ” of this Report.

Research

During the last three fiscal years, SJG did not engage in research activities to any material extent.

Environmental Matters

Information on environmental matters can be found in Note 12 of the financial statements.

Employees

SJG had a total of 504 employees as of December 31, 2016. Of that total, 310 employees are unionized. There are 36 unionized employees represented by the International Brotherhood of Electrical Workers (IBEW) that operate under a collective bargaining agreement that runs through February 2018. The remaining unionized employees are represented by the International Association of Machinists and Aerospace Workers (IAM). Employees represented by the IAM operate under a collective bargaining agreement that runs through August 2017.

Financial Information About Foreign and Domestic Operations and Export Sales

SJG has no foreign operations and export sales are not a part of its business.

Item 1A. Risk Factors
 
SJG operates in an environment that involves risks, many of which are beyond our control. The Company has identified the following risk factors that could cause the Company’s operating results and financial condition to be materially adversely affected. Security holders should carefully consider these risk factors and should also be aware that this list is not all-inclusive of existing risks. In addition, new risks may emerge at any time, and the Company cannot predict those risks or the extent to which they may affect the Company’s businesses or financial performance.

SJG’s business activities are concentrated in southern New Jersey. Changes in the economies of southern New Jersey and surrounding regions could negatively impact the growth opportunities available to SJG and the financial condition of the customers and prospects of SJG.

Changes in the regulatory environment or unfavorable rate regulation may have an unfavorable impact on SJG’s financial performance or condition.  SJG’s business is regulated by the New Jersey Board of Public Utilities (BPU) which has authority over many of the activities of the business including, but not limited to, the rates it charges to its customers, the amount and type of securities it can issue, the nature of investments it can make, the nature and quality of services it provides, safety standards and other matters. The extent to which the actions of regulatory commissions restrict or delay SJG’s ability to earn a reasonable rate of return on invested capital and/or fully recover operating costs may adversely affect its results of operations, financial condition and cash flows.

SJG may not be able to respond effectively to competition, which may negatively impact SJG’s financial performance or condition. Regulatory initiatives may provide or enhance opportunities for competitors that could reduce utility income obtained from existing or prospective customers. Also, competitors may be able to provide superior or less costly products or services based upon currently available or newly developed technologies.

Warm weather, high commodity costs, or customer conservation initiatives could result in reduced demand for natural gas. SJG currently has a conservation incentive program clause that protects its revenues and gross margin against usage that is lower than a set level. Should this clause be terminated without replacement, lower customer energy utilization levels would likely reduce SJG’s net income.

High natural gas prices could cause more of SJG’s receivables to be uncollectible. Higher levels of uncollectibles from utility customers would negatively impact SJG’s income and could result in higher working capital requirements.


7


SJG’s net income could decrease if it is required to incur additional costs to comply with new governmental safety, health or environmental legislation. SJG is subject to extensive and changing federal and state laws and regulations that impact many aspects of its business; including the storage, transportation and distribution of natural gas, as well as the remediation of environmental contamination at former manufactured gas plant facilities.

Increasing interest rates would negatively impact the net income of SJG. SJG is capital intensive, resulting in the incurrence of significant amounts of debt financing. SJG has issued all but $200.0 million of long-term debt either at fixed rates or has utilized interest rate swaps to mitigate changes in floating rates. However, new issues of long-term debt and all variable rate short-term debt are exposed to the impact of rising interest rates. 

The inability to obtain capital, particularly short-term capital from commercial banks, could negatively impact the daily operations and financial performance of SJG. SJG uses short-term borrowings under both a commercial paper program and committed and uncommitted credit facilities provided by commercial banks to supplement cash provided by operations, to support working capital needs, and to finance capital expenditures, as incurred. If the customary sources of short-term capital were no longer available due to market conditions, SJG may not be able to meet its working capital and capital expenditure requirements and borrowing costs could increase.

A downgrade in SJG’s credit ratings could negatively affect its ability to access adequate and cost-effective capital. SJG’s ability to obtain adequate and cost-effective capital depends to a significant degree on its credit ratings, which are greatly influenced by SJG's financial condition and results of operations. If the rating agencies downgrade SJG’s credit ratings, particularly below investment grade, SJG’s borrowing costs would increase. In addition, SJG would likely be required to pay higher interest rates in future financings and potential funding sources would likely decrease.

The inability to obtain natural gas would negatively impact the financial performance of SJG.  SJG’s business is based upon the ability to deliver natural gas to customers. Disruption in the production of natural gas or transportation of that gas to SJG from its suppliers could prevent SJG from completing sales to its customers.

Transporting and storing natural gas involves numerous risks that may result in accidents and other operating risks and costs. SJG’s gas distribution activities involve a variety of inherent hazards and operating risks, such as leaks, accidents, mechanical problems, natural disaster or terrorist activities, which could cause substantial financial losses. In addition, these risks could result in loss of human life, significant damage to property, environmental pollution and impairment of operations, which in turn could lead to substantial losses. In accordance with customary industry practice, SJG maintains insurance against some, but not all, of these risks and losses. The occurrence of any of these events even if fully covered by insurance could adversely affect SJG’s financial position, results of operations and cash flow.

Adverse results in legal proceedings could be detrimental to the financial condition of SJG. The outcomes of legal proceedings can be unpredictable and can result in adverse judgments.

Climate change legislation could impact SJG’s financial performance and condition.  Climate change is receiving ever increasing attention from both scientists and legislators.  The debate is ongoing as to the extent to which our climate is changing, the potential causes of this change and its future impacts.  Some attribute global warming to increased levels of greenhouse gases, which has led to significant legislative and regulatory efforts to limit greenhouse gas emissions.  The outcome of federal and state actions to address global climate change could result in a variety of regulatory programs, including additional charges to fund energy efficiency activities or other regulatory actions.  These actions could affect the demand for natural gas and electricity, result in increased costs to our business and impact the prices we charge our customers.  Because natural gas is a fossil fuel with low carbon content, it is possible that future carbon constraints could create additional demands for natural gas, both for production of electricity and direct use in homes and businesses.  Any adoption by federal or state governments mandating a substantial reduction in greenhouse gas emissions could have far-reaching and significant impacts on the energy industry.  We cannot predict the potential impact of such laws or regulations on our future financial condition, results of operations or cash flows.

SJG's business could be adversely impacted by strikes or work stoppages by its unionized employees. The gas utility operations of SJG are dependent upon employees represented by unions and covered under collective bargaining agreements. A work stoppage could negatively impact operations, which could impact financial results as well as customer relationships.


8


The risk of terrorism may adversely affect the economy as well as SJG's business. An act of terror could result in disruptions of natural gas supplies, cause price volatility in the cost of natural gas and overall could cause instability in the financial and capital markets. This could adversely impact the price and availability of natural gas and adversely affect SJG's results of operations and ability to raise capital.

Our business could be harmed by cybersecurity threats and related disruptions. We rely extensively on information technology systems to process transactions, transmit and store information and manage our business. Disruption or failure of our information technology systems could shut down our facilities or otherwise harm our ability to safely deliver natural gas to our customers, serve our customers effectively, manage our assets, or otherwise materially disrupt our business. Cyber threats are constantly evolving, increasing the difficulty of detecting and successfully defending against them. SJG has experienced such attacks in the past; however, based on information currently available to SJG, none have had a material impact on our business, financial condition, results of operations or cash flows. In response, we have invested in expanded cybersecurity systems and procedures designed to safeguard the continuous and uninterrupted performance of our information technology systems and protect against unauthorized access. However, all information technology systems are potentially vulnerable to security threats, including hacking, viruses, other malicious software, and other unlawful attempts to disrupt or gain access to such systems. There is no guarantee that our cybersecurity systems and procedures will prevent or detect the unauthorized access by experienced computer programmers, hackers or others. An attack on or failure of our information technology systems could result in the unauthorized disclosure, theft, misuse or destruction of customer or employee data or business or confidential information, or disrupt the performance of our information technology systems. These events could expose us to potential liability, litigation, governmental inquiries, investigations or regulatory actions, harm our brand and reputation, diminish customer confidence, disrupt operations, and subject us to payment of fines or other penalties, legal claims by our clients and significant remediation costs.


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Item 1B. Unresolved Staff Comments

None.

Item 2. Properties

The principal property of SJG consists of its gas transmission and distribution systems that include mains, service connections and meters. The transmission facilities carry the gas from the connections with Transco and Columbia to SJG’s distribution systems for delivery to customers. As of December 31, 2016, there were approximately 146.2 miles of mains in the transmission systems and 6,605 miles of mains in the distribution systems.

SJG owns 154 acres of land in Folsom, New Jersey, which is the site of its corporate headquarters. Approximately 140 acres of this property are deed restricted. SJG also has office and service buildings at six other locations in its territory. There is a liquefied natural gas storage, liquefaction and vaporization facility at one of these locations.

As of December 31, 2016, SJG’s utility plant had a gross book value of $2.4 billion and a net book value, after accumulated depreciation, of $2.0 billion. In 2016, $225.3 million was spent on additions to utility plant and there were retirements of property having an aggregate gross carrying value of $16.7 million.
 
Virtually all of SJG’s transmission pipeline, distribution mains and service connections are under streets or highways or on the property of others. The transmission and distribution systems are maintained under franchises or permits or rights-of-way, many of which are perpetual. SJG’s properties (other than property specifically excluded) are subject to a lien of mortgage under which its first mortgage bonds are outstanding. We believe these properties are generally well maintained and in good operating condition.

Item 3. Legal Proceedings

SJG is subject to claims which arise in the ordinary course of business and other legal proceedings. SJG accrues liabilities related to these claims when it can reasonably estimate the amount or range of amounts of probable settlement costs or other charges for these claims. SJG is currently involved in a pricing dispute related to a long-term gas supply contract whereby SJG has sued the supplier to recover amounts that were improperly invoiced. Subsequently, the supplier counter-sued SJG claiming it is owed an additional $14.9 million, plus interest, through December 31, 2016 under the same contract. We believe any monies received or paid associated with the SJG claims would reflect gas costs that would be recovered from SJG's customers through adjusted rates. The Company has accrued approximately $0.6 million and $0.8 million related to all claims in the aggregate, as of December 31, 2016 and 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 our financial position, results of operations or liquidity.

Item 4. Mine Safety Disclosures
Not applicable.

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Part II


Item 5. Market for the Registrant’s Common Equity
Related Stockholder Matters, and Issuer Purchases of Equity Securities

All of the outstanding common stock of SJG (its only class of equity securities) is owned by its parent company, South Jersey Industries, Inc. The common stock is not traded on any stock exchange.

SJG is restricted under its First Mortgage Indenture, as supplemented, as to the amount of cash dividends or other distributions that may be paid on its common stock. As of December 31, 2016, these restrictions did not affect the amount that may be distributed from SJG’s retained earnings. No dividends were declared or paid on SJG's common stock in 2016. SJG declared and paid dividends totaling $40.8 on its common stock in 2015.


Item 6. Selected Financial Data

The following financial data has been obtained from SJG’s audited financial statements (In thousands, except for Ratio Data and Customers):

 
Year Ended December 31,
 
2016
 
2015
 
2014
 
2013
 
2012
Operating Revenues
$
461,055

 
$
534,290

 
$
501,875

 
$
446,480

 
$
421,874

 
 
 
 
 
 
 
 
 
 
Operating Income
$
122,455

 
$
119,585

 
$
113,690

 
$
105,822

 
$
101,762

 
 
 
 
 
 
 
 
 
 
Net Income
$
69,045

 
$
66,578

 
$
66,483

 
$
62,236

 
$
58,241

 
 
 
 
 
 
 
 
 
 
Average Shares of Common Stock Outstanding
2,339

 
2,339

 
2,339

 
2,339

 
2,339

 
 
 
 
 
 
 
 
 
 
Ratio of Earnings to Fixed Charges (1)
5.5x

 
5.4x

 
5.4x

 
5.3x

 
5.5x


 
As of December 31,
 
2016
 
2015
 
2014
 
2013
 
2012
Property, Plant and Equipment, Net
$
1,952,912

 
$
1,770,766

 
$
1,589,369

 
$
1,424,775

 
$
1,285,591

 
 
 
 
 
 
 
 
 
 
Total Assets
$
2,551,923

 
$
2,288,204

 
$
2,185,672

 
$
1,909,126

 
$
1,786,459

 
 
 
 
 
 
 
 
 
 
Capitalization:
 
 
 
 
 
 
 
 
 
Common Equity
$
839,900

 
$
707,927

 
$
680,568

 
$
610,969

 
$
521,395

Long-Term Debt
423,177

 
584,082

 
507,091

 
454,000

 
425,000

Total Capitalization
$
1,263,077

 
$
1,292,009

 
$
1,187,659

 
$
1,064,969

 
$
946,395

 
 
 
 
 
 
 
 
 
 
Total Customers
377,625

 
373,100

 
366,854

 
362,256

 
357,306


(1) The ratio of earnings to fixed charges represents, on a pre-tax basis, the number of times earnings cover fixed charges. Earnings consist of net income, to which has been added fixed charges and taxes based on income of the Company. Fixed charges consist of interest charges.



11


Item 7. Management’s Discussion and Analysis of Financial Condition
and Results of Operations

OVERVIEW:

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

Our service territory covers approximately 2,500 square miles in the southern part of New Jersey. It includes 115 municipalities throughout Atlantic, Cape May, Cumberland and Salem Counties and portions of Burlington, Camden and Gloucester Counties, with an estimated permanent population of 1.2 million. We benefit from our proximity to Philadelphia, PA and Wilmington, DE on the western side of our service territory and the popular shore communities on the eastern side. Continuing expansion of our infrastructure throughout our seven county region has fueled annual customer growth and creates opportunities for future extension into areas not yet served by natural gas. 

We believe there is an ongoing transition of southern New Jersey’s oceanfront communities from seasonal resorts to year round economies. In mainland communities, building expansions in the medical, education and retail sectors contributed to our growth. At present, we serve approximately 71% of households within our territory with natural gas. We also serve southern New Jersey’s diversified industrial base that includes processors of petroleum and agricultural products; chemical, glass and consumer goods manufacturers; and high technology parks.

As of December 31, 2016, we served 377,625 residential, commercial and industrial customers in southern New Jersey, compared with 373,100 customers at December 31, 2015. No material part of our business is dependent upon a single customer or a few customers. Gas sales, transportation and capacity release for 2016 amounted to 148.4 MMdts (million dekatherms), of which 56.8 MMdts were firm sales and transportation, 1.2 MMdts were interruptible sales and transportation and 90.4 MMdts were off-system sales and capacity release. The breakdown of firm sales and transportation includes 42.5% residential, 20.9% commercial, 21.0% industrial, and 15.6% cogeneration and electric generation. At year-end 2016, we served 352,427 residential customers, 24,767 commercial customers and 431 industrial customers.  This includes net additions of 4,334 residential customers and 191 commercial and industrial customers.

We make wholesale gas sales to gas marketers for resale and ultimate delivery to end users. These “off-system” sales are made possible through the issuance of the Federal Energy Regulatory Commission (FERC) Orders No. 547 and 636. Order No. 547 issued a blanket certificate of public convenience and necessity authorizing all parties, which are not interstate pipelines, to make FERC jurisdictional gas sales for resale at negotiated rates, while Order No. 636 allowed us to deliver gas at delivery points on the interstate pipeline system other than our own city gate stations and release excess pipeline capacity to third parties. During 2016, off-system sales amounted to 16.5 MMdts and capacity release amounted to 73.9 MMdts.

Supplies of natural gas available to us that are in excess of the quantity required by those customers who use gas as their sole source of fuel (firm customers) make possible the sale and transportation of gas on an interruptible basis to commercial and industrial customers whose equipment is capable of using natural gas or other fuels, such as fuel oil and propane. The term “interruptible” is used in the sense that deliveries of natural gas may be terminated by us at any time if this action is necessary to meet the needs of higher priority customers as described in our tariffs. In 2016, usage by interruptible customers, excluding off-system customers, amounted to 1.2 MMdts, approximately 1.0% of the total throughput.

Our primary goals are to: 1) provide safe, reliable natural gas service at the lowest cost reasonably possible; 2) promote natural gas as the fuel of choice for residential, commercial and industrial customers; and 3) aid our customers in becoming more energy efficient.

12



The following is a summary of the primary factors we expect to have the greatest impact on our performance and our ability to achieve our goals going forward:

Business Model - We are the primary focus of our parent, SJI, and expect to continue to account for the majority of SJI’s net income by maximizing the growth potential of our service territory.

Customer Growth - Southern New Jersey, our primary area of operations, has not been immune to the issues impacting the new housing market nationally. Residential new construction activity remains steady, supported by growth in higher density and multi-family units. Net customers for SJG grew 1.2% for 2016 as we continue our focus on customer conversions. In 2016, the 4,631 consumers converting their homes and businesses from other heating fuels, such as electric, propane or oil, represented approximately 65% of the total new customer acquisitions for the year. In comparison, conversions over the past five years averaged 5,317 annually. Customers in our service territory typically base their decisions to convert on comparisons of fuel costs, environmental considerations and efficiencies. While oil and propane prices have become more competitive with natural gas in the past two years, affecting the number of conversions, SJG began a comprehensive partnership with the State’s Office of Clean Energy to educate consumers on energy efficiency and to promote the rebates and incentives available to natural gas users.

Regulatory Environment - We are primarily regulated by the New Jersey Board of Public Utilities (BPU). The BPU sets the rates that we charge our rate-regulated customers for services provided and establishes the terms of service under which we operate. We expect the BPU to continue to set rates and establish terms of service that will enable us to obtain a fair and reasonable return on capital invested. The BPU approved a Conservation Incentive Program (CIP) effective October 1, 2006, discussed in greater detail under “Results of Operations,” that protects our net income from severe fluctuations in gas used by our residential, commercial, and small industrial customers. In addition, in February 2013, the BPU issued an Order approving the Accelerated Infrastructure Replacement Program (AIRP), a $141.2 million program to replace cast iron and unprotected bare steel mains and services over a four-year period, with annual investments of approximately $35.3 million. As of December 1, 2016 all AIRP investments are reflected in base rates. Additionally, the BPU issued an Order approving an extension of the AIRP for a 5-year period (“AIRP II”), commencing October 1, 2016, with authorized investments of up to $302.5 million to continue replacing cast iron and unprotected bare steel mains and associated services. SJG earns a return on AIRP II investments until they are included in rate base through annual rate adjustments. The BPU also issued an Order in August 2014 approving the Storm Hardening and Reliability Program (SHARP), a $103.5 million program to replace low-pressure distribution mains and services with high-pressure mains and services on the barrier islands over a three-year period, with annual investments of approximately $34.5 million. The BPU approved an increase in annual revenues from base rates of $3.9 million to reflect the roll-in of $33.7 million of SHARP investments made from July 2015 through June 2016, effective October 1, 2016. SJG earns a return on SHARP investments until they are included in rate base through annual rate adjustments.

Weather Conditions and Customer Usage Patterns - Usage patterns can be affected by a number of factors, such as wind, precipitation, temperature extremes and customer conservation. Our earnings are largely protected from fluctuations in temperatures by the CIP. The CIP has a stabilizing effect on earnings as we adjust revenues when actual usage per customer experienced during an annual period varies from an established baseline usage per customer.

Changes in Natural Gas Prices -   Gas costs are passed on directly to customers without any profit margin added. For the vast majority of our customers, the price for natural gas is set annually, with a regulatory mechanism in place to make limited adjustments to that price during the course of a year. In the event that gas cost increases would justify customer price increases greater than those permitted under the regulatory mechanism, we can petition the BPU for an incremental rate increase. High prices can make it more difficult for our customers to pay their bills and may result in elevated levels of bad-debt expense.

Changes in Interest Rates - We have operated in a relatively low interest rate environment over the past several years. Rising interest rates would raise the expense associated with all issuances of new debt. We have sought to mitigate the impact of a potential rising rate environment by directly issuing fixed-rate debt, or by entering into derivative transactions to hedge against rising interest rates.

Labor and Benefit Costs - Labor and benefit costs have a significant impact on our profitability. Benefit costs, especially those related to pension and health care, have risen in recent years. We seek to manage these costs by revising health care plans offered to existing employees, capping postretirement health care benefits, and changing health care and pension packages offered to new hires. We expect savings from these changes to gradually increase as new hires replace retiring employees.


13


Balance Sheet Strength - Our goal is to maintain a strong balance sheet with an average annual equity-to-capitalization ratio of 46% to 50%. Our equity-to-capitalization ratio, inclusive of short-term debt, was 53% and 49% at the end of 2016 and 2015, respectively. A strong balance sheet assists us in maintaining the financial flexibility necessary to address volatile economic and commodity markets while maintaining a low-risk platform.

Critical Accounting Policies - Estimates and Assumptions - As described in the notes to our financial statements, management must make estimates and assumptions that affect the amounts reported in the financial statements and related disclosures. Actual results could differ from those estimates. Five types of transactions presented in our financial statements require a significant amount of judgment and estimation. These relate to regulatory accounting, derivatives, environmental remediation costs, pension and other postretirement benefit costs, and revenue recognition.

Regulatory Accounting- We maintain our accounts according to the Uniform System of Accounts as prescribed by the BPU. As a result of the ratemaking process, we are required to follow Financial Accounting Standards Board (FASB) ASC Topic 980 – “Regulated Operations.”  We are required under Topic 980 to recognize the impact of regulatory decisions on our financial statements. We are required under our Basic Gas Supply Service (BGSS) clause to forecast our natural gas costs and customer consumption in setting our rates. Subject to BPU approval, we are able to recover or return the difference between gas cost recoveries and the actual costs of gas through a BGSS charge to customers. We record any over/under recoveries as a regulatory asset or liability on the balance sheets and reflect it in the BGSS charge to customers in subsequent years. We also enter into derivatives that are used to hedge natural gas purchases. The offset of the resulting derivative assets or liabilities is recorded as a regulatory asset or liability on the balance sheets. See additional detailed discussions on Rates and Regulatory Actions in Note 3 to the financial statements.

Derivatives - We recognize assets or liabilities for contracts that qualify as derivatives when such contracts are executed. We record contracts at their fair value in accordance with FASB ASC Topic 815 – “Derivatives and Hedging.” We record changes in the fair value of the effective portion of derivatives qualifying as cash flow hedges, net of tax, in Accumulated Other Comprehensive Loss and recognize such changes in the income statement when the hedged item affects earnings. Changes in the fair value of derivatives not designated as hedges are recorded in earnings in the current period. Currently, we do not designate energy-related derivative instruments as cash flow hedges. Certain derivatives that result in the physical delivery of the commodity may meet the criteria to be accounted for as normal purchases and normal sales, if so designated, in which case the contract is not marked-to-market, but rather is accounted for when the commodity is delivered. Due to the application of regulatory accounting principles under Generally Accepted Accounting Principles (United States), derivatives related to gas purchases that are marked-to-market are recorded through our BGSS.  We periodically enter into financial derivatives to hedge against forward price risk. These derivatives are recorded at fair value with an offset to regulatory assets and liabilities through our BGSS, subject to BPU approval (See Notes 3 and 4 to the financial statements). We adjust the fair value of the contracts each reporting period for changes in the market.

As discussed in Notes 13 and 14 of the financial statements, energy-related derivative instruments are traded in both exchange-based and non-exchange-based markets. Exchange-based contracts are valued using unadjusted quoted market sources in active markets and are categorized in Level 1 in the fair value hierarchy established by FASB ASC Topic 820 – “Fair Value Measurements and Disclosures.” Certain non-exchange-based contracts are valued using indicative price quotations available through brokers or over-the-counter, on-line exchanges and are categorized in Level 2. These price quotations reflect the average of the bid-ask mid-point prices and are obtained from sources that management believes provide the most liquid market. Management reviews and corroborates the price quotations with at least one additional source to ensure the prices are observable market information, which includes consideration of actual transaction volumes, market delivery points, bid-ask spreads and contract duration. Derivative instruments that are used to limit our exposure to changes in interest rates on variable-rate, long-term debt are valued using quoted prices on commonly quoted intervals, which are interpolated for periods different than the quoted intervals, as inputs to a market valuation model. Market inputs can generally be verified and model selection does not involve significant management judgment, as a result, these instruments are categorized in Level 2 in the fair value hierarchy.  For non-exchange-based derivatives that trade in less liquid markets with limited pricing information, model inputs generally would include both observable and unobservable inputs.  In instances where observable data is unavailable, management considers the assumptions that market participants would use in valuing the asset or liability.  This includes assumptions about market risks such as liquidity, volatility and contract duration.  Such instruments are categorized in Level 3 in the fair value hierarchy as the model inputs generally are not observable. Counterparty credit risk, and the credit risk of SJG, is incorporated and considered in the valuation of all derivative instruments as appropriate. The effect of counterparty credit risk and the credit risk of SJG on the derivative valuations is not significant.


14


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.

Environmental Remediation Costs - We estimate a range of future costs based on projected investigation and work plans using existing technologies. In preparing financial statements, we record liabilities for future costs using the lower end of the range because a single reliable estimation point is not feasible due to the amount of uncertainty involved in the nature of projected remediation efforts and the long period over which remediation efforts will continue. We update estimates each year to take into account past efforts, changes in work plans, remediation technologies, government regulations and site specific requirements (see Note 12 to the financial statements).

Pension and Other Postretirement Benefit Costs - The costs of providing pension and other postretirement employee benefits are impacted by actual plan experience as well as assumptions of future experience. Employee demographics, plan contributions, investment performance, and assumptions concerning mortality, return on plan assets, discount rates and health care cost trends all have a significant impact on determining our projected benefit obligations. We evaluate these assumptions annually and adjust them accordingly. These adjustments could result in significant changes to the net periodic benefit costs of providing such benefits and the related liabilities recognized by us.

During 2015, several factors resulted in lowering the Company’s expected cost of providing pension and other postretirement healthcare costs in 2016. These include increasing discount rates and updated mortality tables released by the Society of Actuaries in late 2015. Further, the Company changed the structure of its postretirement healthcare plan for retirees to provide them with a fixed contribution to a health reimbursement account and allowing them to obtain coverage from healthcare exchanges, rather than utilizing the Company-provided healthcare plan. These positive factors are partially offset by lower than expected returns on plan assets due to poor performance in the equity markets in 2015.

During 2016, the Company's expected cost of providing pension and other postretirement healthcare in 2017 increased primarily due to decreasing discount rates resulting from lower market interest rates at the end of 2016. As a result, the Company is estimating a $0.7 million net increase in the cost of providing these benefits in 2017.

Additional information regarding investment returns and assumptions can be found in Pension and Other Postretirement Benefits in Note 11 to the financial statements.

Revenue Recognition - Gas revenues are recognized in the period the commodity is delivered to customers. We bill customers monthly at rates approved by the BPU. A majority of our customers have their meters read on a cycle basis throughout the month. As a result, recognized revenues include estimates. For customers that are not billed at the end of each month, we record an estimate to recognize unbilled revenues for gas delivered from the date of the last meter reading to the end of the month. Our unbilled revenue is estimated each month based on natural gas delivered monthly into the system; unaccounted for natural gas based on historical results; customer-specific use factors, when available; actual temperatures during the period; and applicable customer rates.

The BPU allows us to recover gas costs in rates through the BGSS price structure. We defer over/under recoveries of gas costs and include them in subsequent adjustments to the BGSS rate. These adjustments result in over/under recoveries of gas costs being included in rates during future periods. As a result of these deferrals, utility revenue recognition does not directly translate to profitability. While we realize profits on gas sales during the month of providing the utility service, significant shifts in revenue recognition may result from the various recovery clauses approved by the BPU. This revenue recognition process does not shift earnings between periods, as these clauses only provide for cost recovery on a dollar-for-dollar basis (See Notes 3 and 4 to the financial statements).


15


Each CIP year begins October 1 and ends September 30 of the subsequent year. On a monthly basis during a CIP year, we record adjustments to earnings based on weather and customer usage factors, as incurred. Subsequent to each year, we make filings with the BPU to review and approve amounts recorded under the CIP. BPU-approved cash inflows or outflows generally will not begin until the next CIP year and have no impact on earnings at that time.

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

Rates and Regulation - As a public utility, we are subject to regulation by BPU. Additionally, the Natural Gas Policy Act, which was enacted in November 1978, contains provisions for Federal regulation of certain aspects of our business. We are affected by Federal regulation with respect to transportation and pricing policies applicable to pipeline capacity from Transcontinental Gas Pipe Line Company, LLC (our major supplier), Columbia Gas Transmission, LLC and Dominion Transmission, Inc., since such services are provided under rates and terms established under the jurisdiction of the FERC. Our retail sales are made under rate schedules within a tariff filed with, and subject to the jurisdiction of, the BPU. These rate schedules provide primarily for either block rates or demand/commodity rate structures. Our primary rate mechanisms include base rates, the BGSS, Accelerated Infrastructure Programs (AIRP and SHARP), Energy Efficiency Tracker and the CIP.

The CIP is a BPU-approved program that is designed to eliminate the link between our profits and the quantity of natural gas we sell, and to foster conservation efforts. With the CIP, our profits are tied to the number of customers we serve and how efficiently we serve them, thus allowing us to focus on encouraging conservation and energy efficiency among our customers without negatively impacting our net income. The CIP tracking mechanism adjusts earnings based on weather, and also adjusts our earnings when actual usage per customer experienced during an annual period varies from an established baseline usage per customer.  

Utility earnings are recognized during current periods based upon the application of the CIP. The cash impact of variations in customer usage will result in cash being collected from, or returned to, customers during the subsequent CIP year, which runs from October 1 to September 30.

The effects of the CIP on our net income for the last three years and the associated weather comparisons were as follows ($’s in millions):
 
2016
 
2015
 
2014
Net Income Impact:
 
 
 
 
 
CIP – Weather Related
5.9

 
0.9

 
(4.7
)
CIP – Usage Related
4.0

 
(1.9
)
 
2.0

Total Net Income Impact
$
9.9

 
$
(1.0
)
 
$
(2.7
)
 
 
 
 
 
 
Weather Compared to 20-Year Average
8.1% warmer

 
3.1% warmer

 
7.5% colder

Weather Compared to Prior Year
2.5% warmer

 
9.6% warmer

 
4.6% colder


As part of the CIP, we are required to implement additional conservation programs, including customized customer communication and outreach efforts, targeted upgrade furnace efficiency packages, financing offers, and an outreach program to speak to local and state institutional constituents. We are also required to reduce gas supply and storage assets and their associated fees. Note that changes in fees associated with supply and storage assets have no effect on our net income as these costs are passed through directly to customers on a dollar-for-dollar basis.

Earnings accrued and payments received under the CIP are limited to a level that will not cause our return on equity to exceed 9.75% (excluding earnings from off-system gas sales and certain other tariff clauses) and CIP recoveries are limited by the annualized savings attained from reducing gas supply and storage assets.

See additional detailed discussions on Rates and Regulatory Actions in Note 3 to the financial statements.

Environmental Remediation - See detailed discussion concerning Environment Remediation in Note 12 to the financial statements.


16


Competition - Our franchises are non-exclusive. Currently, no other utility provides retail gas distribution services within our territory. We do not expect any other utilities to do so in the foreseeable future because of the extensive investment required for utility plant and related costs. We compete with oil, propane and electricity suppliers for residential, commercial and industrial users, with alternative fuel source providers (wind, solar and fuel cells) based upon price, convenience and environmental factors, and with other marketers/brokers in the selling of wholesale natural gas services. The market for natural gas commodity sales is subject to competition due to deregulation. We enhanced our competitive position while maintaining margins by using an unbundled tariff. This tariff allows full cost-of-service recovery when transporting gas for our customers. Under this tariff, we profit from transporting, rather than selling, the commodity. Our residential, commercial and industrial customers can choose their supplier, while we recover the cost of service through transportation service (see Customer Choice Legislation below).

Customer Choice Legislation - All residential natural gas customers in New Jersey can choose their natural gas commodity supplier under the terms of the “Electric Discount and Energy Competition Act of 1999.” This bill created the framework and necessary time schedules for the restructuring of the state’s electric and natural gas utilities. The Act established unbundling, where redesigned utility rate structures allow natural gas and electric consumers to choose their energy supplier. It also established time frames for instituting competitive services for customer account functions and for determining whether basic gas supply services should become competitive. Customers purchasing natural gas from a provider other than the local utility (marketer) are charged for the gas costs by the marketer and charged for the transportation costs by the utility. The number of customers purchasing their natural gas from marketers averaged 34,130, 36,191 and 41,837 during 2016, 2015 and 2014, respectively.  




17


RESULTS OF OPERATIONS

The following table summarizes the composition of selected gas utility data for the three years ended December 31 (in thousands, except for customer and degree day data):
 
2016
 
2015
 
2014
Utility Throughput – dth:
 
 
 
 
 
 
 
 
 
 
 
Firm Sales -
 
 
 
 
 
 
 
 
 
 
 
Residential
22,126

 
15
%
 
23,852


17
 %

24,508


18
 %
Commercial
4,956

 
3
%
 
5,980


4
 %

5,530


4
 %
Industrial
310

 

 
338




283



Cogeneration and electric generation
1,485

 
1
%
 
1,449


1
 %

1,035


1
 %
Firm Transportation -
 
 

 







Residential
1,975

 
1
%
 
2,427


2
 %

3,291


2
 %
Commercial
6,892

 
5
%
 
6,783


5
 %

7,103


5
 %
Industrial
11,612

 
8
%
 
11,780


9
 %

13,168


10
 %
Cogeneration and electric generation
7,451

 
5
%
 
5,870


4
 %

10,307


7
 %
Total Firm Throughput
56,807

 
38
%
 
58,479

 
42
 %
 
65,225

 
47
 %
Interruptible Sales
2

 

 
20







Interruptible Transportation
1,149

 
1
%
 
1,338


1
 %

1,401


1
 %
Off-System
16,526

 
11
%
 
14,603


11
 %

9,411


7
 %
Capacity Release
73,913

 
50
%
 
62,349


46
 %

62,193


45
 %
Total Utility Throughput
148,397

 
100
%
 
136,789

 
100
 %
 
138,230

 
100
 %
Utility Operating Revenues:
 
 
 
 
 

 
 

 
 

 
 

Firm Sales-
 
 
 
 
 

 
 

 
 

 
 

Residential
$
259,881

 
56
%
 
$
317,491


59
 %

$
279,797


56
 %
Commercial
55,795

 
12
%
 
69,845


13
 %

63,584


13
 %
Industrial
3,126

 
1
%
 
4,083


1
 %

4,070


1
 %
Cogeneration and electric generation
5,257

 
1
%
 
5,666


1
 %

6,037


1
 %
Firm Transportation -
 
 
 
 
 

 
 

 
 

 
 

Residential
14,989

 
3
%
 
16,594


3
 %

20,648


4
 %
Commercial
32,423

 
7
%
 
30,602


6
 %

30,850


6
 %
Industrial
19,594

 
4
%
 
22,106


4
 %

25,737


5
 %
Cogeneration and electric generation
4,472

 
1
%
 
4,920


1
 %

9,531


2
 %
Total Firm Revenues
395,537

 
85
%
 
471,307

 
88
 %
 
440,254

 
88
 %
Interruptible Sales
18

 

 
300




15



Interruptible Transportation
928

 

 
1,373




1,694



Off-System
51,661

 
11
%
 
49,624


9
 %

52,809


11
 %
Capacity Release
11,778

 
3
%
 
10,296


2
 %

5,835


1
 %
Other
1,133

 
1
%
 
1,390


1
 %

1,268



Total Utility Operating Revenues
461,055

 
100
%
 
534,290

 
100
 %
 
501,875

 
100
 %
Less:
 
 
 
 
 

 
 

 
 

 
 

Cost of sales
174,390

 
 
 
245,290

 
 

 
231,216

 
 

Conservation recoveries *
9,202

 
 
 
21,226

 
 

 
24,836

 
 

RAC recoveries *
9,326

 
 
 
9,134

 
 

 
8,255

 
 

EET Recoveries *
2,718

 
 
 
3,611

 
 

 
4,169

 
 

Revenue taxes
1,109

 
 
 
1,250

 
 

 
1,141

 
 

Utility Margin **
$
264,310

 
 
 
$
253,779

 
 

 
$
232,258

 
 

 
 
 
 
 
 
 
 
 
 
 
 

18


 
 
 
 
 
 
 
 
 
 
 
 
Utility Margin:
 
 
 
 
 

 
 

 
 

 
 

Residential
$
162,820

 
62
%
 
$
169,455

 
67
 %
 
$
159,780

 
69
 %
Commercial and industrial
69,396

 
26
%
 
72,149

 
28
 %
 
65,492

 
29
 %
Cogeneration and electric generation
4,898

 
2
%
 
4,738

 
2
 %
 
5,343

 
2
 %
Interruptible
79

 

 
120

 

 
81

 

Off-system & capacity release
4,731

 
2
%
 
4,270

 
2
 %
 
3,023

 
1
 %
Other revenues
2,213

 
1
%
 
2,582

 
1
 %
 
2,131

 
1
 %
Margin before incentive mechanisms
244,137

 
93
%
 
253,314

 
100
 %
 
235,850

 
102
 %
CIP mechanism
16,615

 
6
%
 
(1,798
)
 
(1
)%
 
(4,529
)
 
(2
)%
EET mechanism
3,558

 
1
%
 
2,263

 
1
 %
 
937

 

Utility Margin **
$
264,310

 
100
%
 
$
253,779

 
100
 %
 
$
232,258

 
100
 %
Number of Customers at Year End:
 
 
 
 
 

 
 

 
 

 
 

Residential
352,427

 
93
%
 
348,093

 
93
 %
 
342,155

 
93
 %
Commercial
24,767

 
7
%
 
24,565

 
7
 %
 
24,253

 
7
 %
Industrial
431

 

 
442

 

 
446

 

Total Customers
377,625

 
100
%
 
373,100

 
100
 %
 
366,854

 
100
 %
Annual Degree-Days***
4,292

 
 
 
4,402

 
 

 
4,872

 
 


* Represents expenses for which there is a corresponding credit in operating revenues. Therefore, such recoveries have no impact on our financial results.
** Utility Margin is further defined under the caption "Margin (pre-tax)" below.
*** Each day, each degree of average daily temperature below 65 degrees Fahrenheit is counted as one heating degree-day. Annual degree-days is the sum of the daily totals.

Throughput - Total gas throughput increased 11.6 million decatherms (MMdts), or 8.5%, from 2015 to 2016, primarily due to increases in capacity release. The increase in capacity release volume is primarily related to specific releases made of Columbia pipeline capacity that did not occur in 2015. An increase in third-party supplier deliveries on the Columbia pipeline to SJG’s system freed up capacity at SJG and allowed for additional capacity release of 11.6 MMdts during 2016 compared to 2015. Off-System Sales (OSS) volume also increased 1.9 MMdts, or 13.2%, during 2016 compared to 2015, primarily due to increased opportunity to supply natural gas to gas-fired power generation facilities during the summer months of 2016. These increases were partially offset by a 1.7 MMdts, or 2.9%, decrease in firm throughput primarily due to weather that was 3% warmer than the previous year.

Total gas throughput decreased 1.5 MMdts, or 1.0%, from 2014 to 2015 due to lower throughput in the firm markets. Residential firm sales and transportation throughput decreased by 1.4 MMdts as a result of weather that was 9.6% warmer than prior year, however, the largest decline in firm throughput was experienced in cogeneration transportation, as reflected under “Firm Transportation - Cogeneration and electric generation” in the Throughput table above. Supply disruptions at a cogeneration facility in our territory during 2014 created opportunity for SJG. That customer was being supplied directly by an interstate pipeline. However, with the disruption, SJG had transported a significant volume of commodity to this cogeneration facility to meet its needs in 2014. That disruption has since been remedied, resulting in lower firm transportation throughput in 2015. Partially offsetting these decreases was a 5.2 MMdts increase in OSS throughput from 2014 to 2015. This was primarily due to warmer than normal weather, which created less demand in the Company’s service territory and more supply available for OSS.


19


Operating Revenues – Revenues decreased $73.2 million, or 13.7%, during 2016 compared with 2015. Total firm revenue was $75.8 million, or 16.1%, lower in 2016 compared to the prior year due to several factors. Firm throughput was lower during 2016, compared to the prior year, as discussed above under “Throughput.” The impact of this reduction in throughput lowered SJG’s recovery of natural gas costs through the BGSS mechanism by $38.3 million. In addition, SJG reduced its BGSS rate effective October 1, 2015 and 2016 by 18.6% and 32.9%, respectively, further reducing revenue by $34.7 million during 2016. Finally, SJG provided a $20.0 million and $10.0 million BGSS bill credit to its residential and small commercial customers in January 2016 and December 2016, respectively, of which $28.0 million reduced revenue for 2016, after consideration for sales tax. While changes in natural gas costs and BGSS recoveries/refunds fluctuate from period to period, SJG does not profit from the sale of the commodity. Therefore, fluctuations in Operating Revenue and Cost of Sales, such as those discussed above, did not have an impact on SJG’s profitability. The addition of 4,525 customers in 2016 partially offset the decreases mentioned above. While warmer weather decreased firm sales volume and revenue, the revenue decrease has little impact on SJG profitability under the operation of the CIP, as discussed below under the caption "Margin (pre-tax)."

Higher OSS volumes, discussed above under "Throughput," resulted in a $2.0 million, or 4.1%, increase in OSS revenues during 2016, compared with 2015. The impact of changes in OSS activity does not have a material impact on the earnings of SJG, as SJG is required to return 85% of the profits of such activity to its ratepayers. Earnings from OSS can be seen in the "Margin" table above.

Revenues increased $32.4 million, or 6.5%, during 2015 compared with 2014, due to higher firm revenue. Total firm revenue increased $31.1 million, or 7.1%, in 2015 as a result of the settlement of SJG’s base rate case and a 22.1% increase in SJG’s periodic BGSS rate, both effective October 1, 2014, as discussed in Note 3 and 4 to the financial statements. SJG subsequently decreased its periodic BGSS rate by 18.6% effective October 1, 2015; however, the impact of the higher rate in effect for the majority of the year increased revenue by approximately $25.4 in 2015, compared with 2014. While changes in gas costs and BGSS recoveries/refunds fluctuate from period to period, SJG does not profit from the sale of the commodity. Therefore, corresponding fluctuations in Operating Revenue or Cost of Sales have no impact on Company profitability, as further discussed below under the caption "Margin (pre-tax)". In addition, the settlement of SJG’s base rate case added $15.5 million of incremental revenue to 2015, compared with 2014. The addition of 6,246 additional customers in 2015 also contributed to higher firm revenue; however, the impact of 9.6% warmer weather more than offset the impact of customer growth during the year. While warmer weather decreased firm sales volume and revenue, the revenue decrease has little impact on Company profitability under the operation of the CIP, as discussed below under the caption "Margin (pre-tax)."

Margin (pre-tax) - Our margin is defined as natural gas revenues less natural gas costs; volumetric and revenue based energy taxes; and regulatory rider expenses. We believe that margin provides a more meaningful basis for evaluating utility operations than revenues since natural gas costs, energy taxes and regulatory rider expenses are passed through to customers, and, therefore, have no effect on our profitability. Natural gas costs are charged to operating expenses on the basis of therm sales at the prices approved by the BPU through our BGSS tariff.

Total margin increased $10.5 million, or 4.1%, from 2015. The rolling into base rates of SHARP investments of approximately $36.6 million on October 1, 2015 contributed approximately $3.5 million of additional margin in 2016. In addition, the rolling into base rates of AIRP investments of $74.5 million on December 1, 2016 contributed approximately $1.5 million of additional margin in 2016. Net customer additions of 4,525 over the twelve-month period ended December 31, 2016, representing 1.2% growth over the prior year, contributed approximately $4.0 million in additional margin.

Total Margin in 2015 increased $21.5 million, or 9.3%, from 2014 primarily due to the settlement of the base rate case effective October 1, 2014 and customer additions. The base rate case settlement contributed approximately $15.5 million in additional margin in 2015. Net customer additions of 6,246 over the twelve-month period ended December 31, 2015, representing 1.7% growth over the prior year, contributed approximately $3.7 million in additional margin.

The CIP tracking mechanism adjusts earnings when actual usage per customer experienced during the period varies from an established baseline usage per customer. As reflected in the margin table and the CIP table above, the CIP mechanism protected $16.6 million, or $9.9 million after taxes, during 2016, due to weather that was 8.1% warmer than average and customer usage variations.

The CIP mechanism reduced margin by $1.8 million, or $1.0 million after taxes, during 2015, primarily due to customer usage variations. The CIP mechanism reduced margin by $4.5 million, or $2.7 million after taxes, during 2014, primarily due to weather that was colder than normal.



20


Operating Expenses - A summary of changes in other operating expenses (in thousands):

 
2016 vs. 2015
 
2015 vs. 2014
Operations
$
(12,227
)
 
$
5,408

Maintenance
$
1,366

 
$
2,726

Depreciation
$
6,067

 
$
4,041

Energy and Other Taxes
$
(411
)
 
$
271


Operations – Operations expense decreased $12.2 million during 2016, as compared with 2015. The decrease is primarily comprised of the following:

Lower expenses associated with the New Jersey Clean Energy Program and Energy Efficiency Programs, which experienced net decreases of $12.9 million in 2016, compared with 2015. Such costs are recovered on a dollar-for-dollar basis; therefore, SJG experiences an offsetting decrease in revenue during 2016. This was due to a reduction in the approved level of recovery of such costs, as well as lower recoveries resulting from warmer weather as previously discussed under “Throughput.”

SJG also saw expenses associated with write-offs of uncollectible customer accounts receivable decrease $7.2 million in 2016, compared with 2015. The decrease in write-offs resulted from fewer customer accounts being eligible to be written off in 2016 as a result of an improvement in the aging of receivables.

The decreases noted above were partially offset by higher expenses in various areas, primarily those associated with corporate support, governance and compliance costs, primarily associated with our parent, SJI, which increased $4.8 million in 2016, compared with 2015.

In addition, expenses associated with the operation of the Company's management systems increased $1.8 million in 2016, compared with 2015, primarily due to incremental costs associated with new systems.

Operations expense increased $5.4 million during 2015, as compared with 2014. The increase is primarily comprised of the following:

Expenses associated with write-offs of uncollectible customer accounts receivable increased $4.3 million in 2015, as compared with 2014. The increase in write-offs resulted from an increase in the aging of receivables following a very cold 2014-2015 winter season.

SJG also increased its reserve for uncollectible accounts, resulting in $1.5 million of additional expense in 2015, as compared with 2014. Changes in the uncollectible reserve are the result of fluctuations in levels of customer accounts receivables balances. Accounts receivable was higher as of December 31, 2015 due to higher customer billing rates in effect for the majority of 2015, compared with 2014 (See discussion under “Rates and Regulatory Actions"), in addition to customer growth.

Customer service expense increased $1.5 million in 2015, compared with 2014, due to increased staffing levels to achieve desired customer satisfaction levels and increased collection activities.

The cost of providing postretirement healthcare and pension costs increased $1.2 million in 2015, compared with 2014, as the result of lower discount rates used to calculate such costs in 2015 (See discussion under “Pension and Other Postretirement Benefits”).

Expense associated with the operation of the Company’s management systems increased $1.5 million in 2015, compared with 2014, primarily due to incremental cost associated with the new customer billing and work management systems placed in service near the end of 2014.

These were partially offset by lower expenses associated with the New Jersey Clean Energy Program and Energy Efficiency Programs which decreased $4.2 million in 2015, compared with 2014. Such costs are recovered on a dollar-for-dollar basis; therefore, SJG experienced an offsetting decrease in revenues during 2015.



21




Maintenance – Maintenance expense increased $1.4 million during 2016, compared with 2015, primarily due to increased field activity related to the maintenance of services.

Maintenance expense increased $2.7 million during 2015, compared with 2014, due to the BPU-approved amortization and recovery of previously deferred maintenance costs, primarily those associated with a federally-mandated pipeline integrity management program. Such amortizations, which are being recovered through an offsetting amount in revenues beginning in October 2014, were $0.8 million higher in 2015, compared with 2014. SJG experienced an increase in Remediation Adjustment Clause (RAC) expense amortization of $0.9 million over 2014, primarily as a result of increased spending on environmental remediation in recent years. As discussed in Notes 3 and 4 to the financial statements, RAC costs are recovered from ratepayers; therefore, SJG experienced an offsetting change in revenue during 2015. Also contributing to the increase in maintenance expense was higher distribution operations expense. Such expenses increased $1.1 million in 2015, compared with 2014, as a result of increased field activity related to the maintenance of services.

Depreciation - Depreciation expense increased $6.1 million and $4.0 million in 2016 and 2015, respectively, due mainly to our continuing investment in utility plant. SJG’s investment in utility plant during 2016, 2015, and 2014 was $225.3 million, $207.8 million and $200.0 million, respectively. The increased spending in recent years was a direct result of New Jersey's stimulus and infrastructure improvement efforts, which included the approval of SJG’s AIRP and SHARP, as discussed under “Rates and Regulation,” in addition to significant investment in new technology systems, as previously discussed under Operations Expense.

Energy and Other Taxes – Energy and Other Taxes decreased $0.4 million during 2016, compared with 2015, primarily due to lower revenue-based taxes, which decreased as a result of lower revenue during 2016, as previously discussed under “Operating Revenues” above. Changes in Energy and Other Taxes in 2015, compared with 2014, were not significant.

Other Income and Expense - Changes in Other income and expense during 2016, compared with 2015, were not significant. Other income and expense was $1.7 million lower in 2015, compared to 2014, primarily due to poor financial market performance during the latter part of the year. In 2015, SJG realized a loss of $0.3 million on its available-for-sale securities, compared to a realized gain of $0.9 million in 2014. Also adding to Other Income in 2014 was a higher allowance for equity funds used during construction as the Company made significant investment in new technology systems. As those investments in systems grew from 2013 to 2014, so did the resulting income. However, once placed in service in the latter part of 2014, such income ceased.
    
Interest Charges – Interest charges decreased $2.0 million in 2016, compared with 2015, primarily due to higher capitalization of interest costs on construction during 2016. This was a result of accumulating capital investments under the AIRP. AIRP investments are approved by the BPU to accrue interest on construction until such time they are rolled into base rates. This is partially offset by interest on $61.0 million of long-term debt issued in January 2016 (see Note 7 to the financial statements).

Interest charges increased $2.0 million in 2015 , as a result of rolling in investments of SJG’s accelerated investment programs into rates. Capital investments under the AIRP and Capital Investment Recovery Tracker (CIRT) programs were rolled into base rates effective October 1, 2014 and 2013, respectively. Such program spend was permitted by the BPU to accrue interest on construction, which reduces interest expense, until such time they were rolled into base rates. The Company also placed two major technology systems into service during the fourth quarter of 2014, thereby lowering the capitalization of interest on construction from 2014 to 2015.

Income Taxes – Income tax expense generally fluctuates as income before taxes changes.
    

LIQUIDITY AND CAPITAL RESOURCES:

Liquidity needs are driven by factors that include natural gas commodity prices; the impact of weather on customer bills; lags in fully collecting gas costs from customers under the BGSS charge; the timing of construction and remediation expenditures and related permanent financings; mandated tax payment dates; both discretionary and required repayments of long-term debt; and the amounts and timing of dividend payments.

Cash Flows from Operating Activities - Cash generated from operating activities constitutes our primary source of liquidity and varies from year-to-year due to the impact of weather on customer demand and related gas purchases, customer usage factors related to conservation efforts and the price of the natural gas commodity, inventory utilization and recoveries provided through our various rate mechanisms. Net cash provided by operating activities was $142.2 million in 2016, $164.6 million in 2015 and $103.5 million in 2014.

22



Net cash provided by operating activities decreased in 2016 as compared with 2015, primarily due to lower collections under regulatory clauses due to warmer weather experienced throughout 2016, as well as higher costs associated with environmental remediation projects. These impacts were partially offset by SJG not making a pension payment in 2016 as compared with 2015. In 2015, SJG made a $12.0 million pension contribution as a result of a decline in the discount rate and new mortality tables released at the end of 2014, both of which negatively impacted the funding status of the pension plans. The Company strives to keep its pension plans fully funded. When factors such as lesser than expected asset performance and/or declining discount rates negatively impact the funding status of the plans, the Company increases its contributions to offset that funding shortfall.

Net cash provided by operations increased in 2015 as compared with 2014 due to higher collections of previously deferred gas costs. Collection of those gas costs had been deferred under the BGSS clause in 2014 as a result of the extremely cold weather experienced during the first quarter of 2014. This benefit was offset by a $12.0 million pension contribution made by SJG as a result of a decline in the discount rate and new mortality tables released at the end of 2014, both of which negatively impacted the funding status of the pension plans. No such contribution was made in 2014. The Company strives to keep its pension plans fully funded. When factors such as lesser than expected asset performance and/or declining discount rates negatively impact the funding status of the plans, the Company increases its contributions to supplant that funding shortfall. 

Cash Flows from Investing Activities - We have a continuing need for cash resources for capital purchases, primarily to invest in new and replacement facilities and equipment. Cash used for capital expenditures was $225.3 million, $207.8 million and $200.0 million in 2016, 2015 and 2014, respectively, primarily due to infrastructure improvements that continue to support SJG’s growth. The increased capital expenditures during the past three years were the direct result of the Company’s AIRP and SHARP programs; the AIRP program began in 2009 and the SHARP program began in 2014. See additional details under “Rates and Regulation.”

For capital expenditures, including those under the AIRP and SHARP, SJG expects to use short-term borrowings under both our commercial paper program and lines of credit from commercial banks to finance capital expenditures as incurred.  From time to time, the Company may refinance the short-term debt incurred to support capital expenditures with long-term debt.

Cash Flows from Financing Activities - We use short-term borrowings under both our commercial paper program and lines of credit from commercial banks to supplement cash from operations, to support working capital needs and to finance capital expenditures as incurred. From time to time, we refinance short-term debt incurred to finance capital expenditures with long-term debt. Debt is incurred primarily to expand and upgrade our gas transmission and distribution system and to support seasonal working capital needs related to inventories and customer receivables.  

In January 2016, SJG issued $61.0 million of long-term debt on its $200.0 million multiple-draw term facility offered by a syndicate of banks. This facility bore interest at a floating rate based on LIBOR plus a spread determined by SJG's credit ratings. The total outstanding amount under this facility as of December 31, 2016 was $200.0 million, which was classified in current portion of long-term debt on the balance sheets as it was due within one year. In January 2017, SJG issued $200.0 million aggregate principal amount of Medium Term Notes (MTN's), Series E, 2017, due January 2047, with principal repayments beginning in 2025. The MTN's bear interest at an annual rate of 3.0% payable semiannually. Proceeds were used to pay down the $200.0 million multiple-draw term facility which was set to expire in June 2017 (see Note 17 to the financial statements).

In July 2016, SJG retired $17.0 million of 4.60% MTN's at maturity.

In August 2016, SJG retired $10.0 million of 5.437% MTN's at maturity.

SJG makes payments of $0.9 million annually through December 2025 toward the principal amount of 3.63% MTN's, including a payment made in 2016. As such, $0.9 million of the total outstanding amount on this debt is classified in current portion of long-term debt on the balance sheets as it is due within one year (see Note 7 to the financial statements).

In January 2017, SJG entered into an unsecured, $200.0 million term loan credit agreement ("Credit Agreement"), which is syndicated among seven banks. Term loans under the Credit Agreement bear interest at a variable base rate or a variable LIBOR rate, at SJG's election. Under the Credit Agreement, SJG can borrow up to an aggregate of $200.0 million until July 2018, of which SJG borrowed $73.0 million on January 31, 2017. All loans under the Credit Agreement become due in January 2019.
In August 2015, SJG retired $10.0 million aggregate principal amount of 5.387% MTN's at maturity.


23


In September 2015, SJG redeemed early $0.1 million of the $25.0 million aggregate principal amount variable rate demand bonds that were issued in September 2008. SJG had previously spent all but $0.1 million of the debt proceeds and was permitted under the debt agreement to utilize those remaining funds to redeem the debt early. In December 2015, SJG paid $0.9 million toward the principal amount of 3.63% MTN's due December 2025.

SJI contributed an equity infusion of $65.0 million and $25.0 million in 2016 and 2014, respectively. SJI did not contribute any equity to SJG in 2015.

Credit facilities and available liquidity as of December 31, 2016 were as follows (in thousands):
 
Total Facility
 
Usage
 
Available Liquidity
 
Expiration Date
Commercial Paper/Revolving Credit Facility
$
200,000

 
$
105,100

(A)
$
94,900

 
May 2018
 
 
 
 
 
 
 
 
Uncommitted Bank Lines
10,000

 

 
10,000

 
August 2017
 
 
 
 
 
 
 
 
Total
$
210,000

 
$
105,100

 
$
104,900

 
 

(A) Includes letters of credit outstanding in the amount of $0.8 million

The revolving credit facility contains one financial covenant limiting the ratio of indebtedness to total capitalization (as defined in the credit agreement) to not more than 0.65 to 1, measured at the end of each fiscal quarter. SJG was in compliance with this covenant as of December 31, 2016.

SJG has a commercial paper program under which SJG may issue short-term, unsecured promissory notes to qualified investors up to a maximum aggregate amount outstanding at any time of $200.0 million.  The notes will have fixed maturities which will vary by note, but may not exceed 270 days from the date of issue. Proceeds from the notes will be used for general corporate purposes. SJG uses the commercial paper program in tandem with its $200.0 million revolving credit facility and does not expect the principal amount of borrowings outstanding under the commercial paper program and the credit facility at any time to exceed an aggregate of $200.0 million.

Average borrowings outstanding under these credit facilities during the twelve months ended December 31, 2016 and 2015 were $71.5 million million and $118.1 million, respectively. The maximum amount outstanding under these credit facilities during the twelve months ended December 31, 2016 and 2015 were $141.7 million and $162.3 million, respectively.

Based upon the existing credit facilities and a regular dialogue with our banks, we believe there will continue to be sufficient credit available to meet our future liquidity needs.

In December 2015, SJG filed a petition with the BPU to issue up to $400.0 million of long-term debt securities in various forms including MTN's and unsecured debt, with maturities of more than 12 months, over the next three years. This petition was approved in March 2016.

As of December 31, our capital structure was as follows:
 
2016
 
2015
Common Equity
53
%
 
49
%
Long-Term Debt
40
%
 
42
%
Short-Term Debt
7
%
 
9
%
 
 
 
 
Total
100
%
 
100
%


24


COMMITMENTS AND CONTINGENCIES:

SJG has a continuing need for cash resources and capital, primarily to invest in new and replacement facilities and equipment, working capital, and for environmental remediation costs. Cash outflows for capital expenditures for 2016 amounted to $225.3 million. Management estimates net cash outflows for construction projects for 2017, 2018 and 2019, to be approximately $249.7 million, $236.0 million and $292.7 million, respectively. Costs for remediation projects for the year of 2016 amounted to $39.7 million, net of recoveries from ratepayers. Total cash outflows for remediation projects are expected to be $38.9 million, $31.5 million and $50.5 million for 2017, 2018, and 2019, respectively, prior to recoveries from ratepayers. As discussed in Notes 3 and 12 to the financial statements, environmental remediation costs are subject to recovery from ratepayers, however, recovery from insurance carriers has been exhausted as policy limits have been reached. The recoveries from ratepayers under the RAC mechanism are expected to approximate $9.8 million, $15.6 million and $21.2 million in 2017, 2018, and 2019, respectively.

STANDBY LETTER OF CREDIT - SJG provided a $25.2 million letter of credit, under a separate credit facility from those it borrows under to provide liquidity support for the remarketing of variable-rate demand bonds issued through the NJEDA. The bonds were used to finance the expansion of SJG’s natural gas distribution system, as discussed in Note 7 to the financial statements. The replacement letter of credit expires in August 2018, and as a result, the related bonds are included in long-term debt.

We have certain commitments for both pipeline capacity and gas supply for which we pay fees regardless of usage. Those commitments as of December 31, 2016, average $67.1 million annually and total $319.5 million over the contracts’ lives. Approximately 34% of the financial commitments under these contracts expire during the next five years. We expect to renew each of these contracts under renewal provisions as provided in each contract. We recover all prudently incurred fees through rates via the BGSS clause.

In 2011, while in its normal course of business, SJG entered into long-term contracts for natural gas supplies. SJG committed to purchase a minimum of 6,250 dts/d and up to 25,000 dts/d of natural gas, from one supplier, for an original term of eight years at index-based prices. The obligation for this purchase has not been included in the Company's contractual obligations discussed below because the actual volumes and prices are not fixed.

The following table summarizes our contractual cash obligations and their applicable payment due dates as of December 31, 2016 (in thousands):
Contractual Cash Obligations
Total
 
Up to
1 Year
 
Years
2 & 3
 
Years
4 & 5
 
More than
5 Years
Principal Payments on Long-Term Debt
$
645,082

 
$
215,909

 
$
57,818

 
$
45,818

 
$
325,537

Interest on Long-Term Debt
180,314

 
21,084

 
34,909

 
29,903

 
94,418

Commodity Supply Purchase Obligations
356,711

 
88,476

 
105,338

 
37,731

 
125,166

Environmental Remediation Costs
153,047

 
45,018

 
81,932

 
6,419

 
19,678

Construction Obligations
144,109

 
144,109

 

 

 

Operating Leases
391

 
173

 
194

 
24

 

New Jersey Clean Energy Program
14,969

 
14,969

 

 

 

Other Purchase Obligations
2,876

 
2,876

 

 

 

 
 
 
 
 
 
 
 
 
 
Total Contractual Cash Obligations
$
1,497,499

 
$
532,614

 
$
280,191

 
$
119,895

 
$
564,799


Long-Term Debt in the table above does not include unamortized debt issuance costs of $6.0 million, which were reclassified to Long-Term Debt on the balance sheets to conform to ASU 2015-03 (see Note 1 to the financial statements).

Expected asset retirement obligations and the liability for unrecognized tax benefits are not included in the table above as the total obligation cannot be calculated due to the subjective nature of these costs and timing of anticipated payments. SJG did not make a pension plan contribution in 2016. SJG made contributions to its employee pension plans totaling $8.0 million in January 2017. Future pension contributions beyond January 2017 cannot be determined at this time. SJG's regulatory obligation to contribute $3.6 million annually to our postretirement benefit plans’ trusts, as discussed in Note 11 to the financial statements, is also not included as its duration is indefinite.


25


Off-Balance Sheet Arrangements - We have no off-balance sheet financing arrangements.

Pending Litigation - SJG is subject to claims which arise in the ordinary course of business and other legal proceedings. SJG accrues 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. SJG is currently involved in a pricing dispute related to a long-term gas supply contract whereby SJG has sued the supplier to recover amounts that were improperly invoiced. Subsequently, the supplier counter-sued SJG claiming it is owed an additional $14.9 million, plus interest, through December 31, 2016 under the same contract. We believe any monies received or paid associated with the SJG claims would reflect gas costs that would be recovered from SJG's customers through adjusted rates. The Company has accrued approximately $0.6 million and $0.8 million related to all claims in the aggregate, as of December 31, 2016 and 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 to have a material effect on our financial position, results of operations or liquidity.


Item 7a. Quantitative and Qualitative Disclosures about Market Risks

MARKET RISKS:

Commodity Market Risks - We are involved in buying, selling, transporting and storing natural gas and are subject to market risk due to price fluctuations. To hedge against this risk, we enter into a variety of physical and financial transactions including forward contracts, futures and options agreements. To manage these transactions, we have a well-defined risk management policy approved by our Board of Directors that includes volumetric and monetary limits. Management reviews reports detailing activity daily. Generally, the derivative activities described above are entered into for risk management purposes.

We transact commodities on a physical and financial basis. South Jersey Resources Group, LLC (SJRG), an affiliate by common ownership, previously managed some of our risk by entering into the types of transactions noted above. As part of our gas purchasing strategy, we use financial contracts to hedge against forward price risk. These contracts are recoverable through our BGSS, subject to BPU approval. The majority of our contracts are typically less than twelve-months long.

The fair value and maturity of these energy trading and hedging contracts determined using mark-to-market accounting as of December 31, 2016 is as follows (in thousands):
Assets
 
 
 
 
 
 
Source of Fair Value
 
Maturity
< 1 Year
 
Maturity
1 - 3 Years
 
Total
Prices Actively Quoted (NYMEX)
 
$
4,394

 
$
373

 
$
4,767

Prices Provided by Other External Sources (Basis)
 

 

 

Prices based on internal models or other valuable methods
 
1,040

 

 
1,040

Total
 
$
5,434

 
$
373

 
$
5,807

Liabilities
 
 
 
 
 
 
 
 
Maturity
 
Maturity
 
 
Source of Fair Value
 
< 1 Year
 
1 - 3 Years
 
Total
Prices Actively Quoted (NYMEX)
 
$
6

 
$

 
$
6

Prices Provided by Other External Sources (Basis)
 
1,252

 

 
1,252

Prices based on internal models or other valuable methods
 
114

 

 
114

Total
 
$
1,372

 
$

 
$
1,372


NYMEX (New York Mercantile Exchange) is the primary national commodities exchange on which natural gas is traded. Basis represents the price of a NYMEX natural gas futures contract adjusted for the difference in price for delivering the gas at another location. Contracted volumes of our NYMEX contracts are 7.9 MMdt with a weighted-average settlement price of $3.08 per dt. Contracted volumes of our Basis contracts are 1.3 MMdt with a weighted average settlement price of $1.62 per dt.


26


A reconciliation of our estimated net fair value of energy-related derivatives follows (in thousands):

Net Derivatives — Energy Related Liability, January 1, 2016
$
(4,699
)
Contracts Settled During the Twelve Months ended December 31, 2016, Net
4,412

Other Changes in Fair Value from Continuing and New Contracts, Net
4,722

Net Derivatives — Energy Related Asset, December 31, 2016
$
4,435


Interest Rate Risk - Our exposure to interest rate risk relates primarily to variable-rate borrowings. Variable-rate debt outstanding at December 31, 2016, was $304.3 million and averaged $304.5 million during 2016. A hypothetical 100 basis point (1%) increase in interest rates on our average variable-rate debt outstanding would result in a $1.6 million increase in our annual interest expense, net of tax. The 100 basis point increase was chosen for illustrative purposes, as it provides a simple basis for calculating the impact of interest rate changes under a variety of interest rate scenarios. Over the past five years, the change in basis points (b.p.) of our average monthly interest rates from the beginning to end of each year was as follows: 2016 - 19 b.p. increase; 2015 - 20 b.p. increase; 2014 - 32 b.p. increase; 2013 - 14 b.p. decrease; and 2012 - 1 b.p. decrease. As of December 31, 2016, our average interest rate on variable-rate debt was 1.27%.

We issue long-term debt either at fixed rates or use interest rate derivatives to limit our exposure to changes in interest rates on variable-rate, long-term debt. As of December 31, 2016, the interest costs on all but $200.0 million of our long-term debt was either at a fixed-rate or hedged via an interest rate derivative. Consequently, interest expense on existing long-term debt is not significantly impacted by changes in market interest rates.


27


Item 8. Financial Statements and Supplementary Data


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholder of
South Jersey Gas Company
Folsom, New Jersey

We have audited the accompanying balance sheets of South Jersey Gas Company (the "Company") as of December 31, 2016 and 2015, and the related statements of income, comprehensive income, cash flows, and changes in common equity and comprehensive income, for each of the three years in the period ended December 31, 2016.  Our audits also included the financial statement schedule listed in the Index at Item 15(a)2.  These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such financial statements present fairly, in all material respects, the financial position of South Jersey Gas Company as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.



/s/ Deloitte & Touche LLP
Philadelphia, Pennsylvania
February 27, 2017


28



SOUTH JERSEY GAS COMPANY
STATEMENTS OF INCOME
(In Thousands)

 
Year Ended December 31,
 
2016
 
2015
 
2014
Operating Revenues
$
461,055

 
$
534,290

 
$
501,875

Operating Expenses:
 
 
 
 
 

Cost of Sales (Excluding depreciation)
174,390

 
245,290

 
231,216

Operations
95,609

 
107,836

 
102,428

Maintenance
17,549

 
16,183

 
13,457

Depreciation
47,432

 
41,365

 
37,324

Energy and Other Taxes
3,620

 
4,031

 
3,760

Total Operating Expenses
338,600

 
414,705


388,185

Operating Income
122,455

 
119,585


113,690

Other Income and Expense
3,831

 
3,844

 
5,560

Interest Charges
(17,875
)
 
(19,906
)
 
(17,872
)
Income Before Income Taxes
108,411

 
103,523


101,378

Income Taxes
(39,366
)
 
(36,945
)
 
(34,895
)
Net Income
$
69,045

 
$
66,578


$
66,483


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



29


SOUTH JERSEY GAS COMPANY
STATEMENTS OF COMPREHENSIVE INCOME
(In Thousands)

 
Year Ended December 31,
 
2016
 
2015
 
2014
Net Income
$
69,045

 
$
66,578

 
$
66,483

 
 
 
 
 
 
Other Comprehensive Income (Loss), Net of Tax:*
 
 
 
 
 
 
 
 
 
 
 
Postretirement Liability Adjustment
(2,197
)
 
1,617

 
(3,165
)
Unrealized Gain (Loss) on Available-for-Sale Securities
98

 
(23
)
 
(472
)
Unrealized Gain on Derivatives - Other
27

 
23

 
27

 
 
 
 
 
 
Other Comprehensive (Loss) Income - Net of Tax*
(2,072
)
 
1,617

 
(3,610
)
 
 
 
 
 
 
Comprehensive Income
$
66,973

 
$
68,195

 
$
62,873


* Determined using a combined statutory tax rate of 40% in each of 2016, 2015 and 2014.


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


30



SOUTH JERSEY GAS COMPANY
STATEMENTS OF CASH FLOWS
(In Thousands)
 
Year Ended December 31,
 
2016
 
2015
 
2014
Cash Flows from Operating Activities:
 
 
 
 
 
Net Income
$
69,045

 
$
66,578

 
$
66,483

Provided by Operating Activities:
 
 
 
 
 

Depreciation and Amortization
63,901

 
58,668

 
52,155

Provision for Losses on Accounts Receivable
6,993

 
14,689

 
9,417

CIP Receivable/Payable
(24,943
)
 
(7,324
)
 
15,226

Deferred Gas Costs - Net of Recoveries
11,753

 
28,648

 
(44,976
)
Deferred SBC Costs - Net of Recoveries
(7,102
)
 
9,557

 
11,048

Environmental Remediation Costs - Net of Recoveries
(39,735
)
 
(22,058
)
 
(8,248
)
Deferred and Noncurrent Income Taxes and Credits - Net
40,980

 
39,148

 
32,193

Gas Plant Cost of Removal
(6,070
)
 
(5,096
)
 
(4,848
)
Pension Contribution

 
(12,020
)
 

Changes in:
 
 
 
 
 
Accounts Receivable
(24,867
)
 
8,597

 
(14,667
)
Inventories
2,696

 
11,198

 
(3,820
)
Prepaid and Accrued Taxes - Net
3,980

 
(7,129
)
 
(6,508
)
Other Prepayments and Current Assets
(448
)
 
(9,717
)
 
131

Gas Purchases Payable
14,879

 
(13,423
)
 
(1,873
)
Accounts Payable and Other Accrued Liabilities
35,982

 
(2,264
)
 
11,302

Other Assets
(7,065
)
 
4,996

 
(7,481
)
Other Liabilities
2,183

 
1,576

 
(2,006
)
Net Cash Provided by Operating Activities
142,162

 
164,624

 
103,528

 
 
 
 
 
 
Cash Flows from Investing Activities:
 

 
 

 
 

Capital Expenditures
(225,287
)
 
(207,785
)
 
(200,008
)
Note Receivable
9,916

 
(9,916
)
 

Net Sale (Purchase) of Restricted Investments in Margin Accounts
6,737

 
1,091

 
(7,281
)
Net Sale of Restricted Investments from Escrowed Loan Proceeds

 
101

 

Investment in Long-Term Receivables
(10,886
)
 
(19,033
)
 
(13,024
)
Proceeds from Long-Term Receivables
10,014

 
8,769

 
6,544

Net Cash Used in Investing Activities
(209,506
)
 
(226,773
)
 
(213,769
)
 
 
 
 
 
 
Cash Flows from Financing Activities:
 

 
 

 
 

Net (Repayments of) Borrowings from Short-Term Credit Facilities
(30,100
)
 
33,000

 
35,900

Proceeds from Issuance of Long-Term Debt
61,000

 
80,000

 
89,000

Principal Repayments of Long-Term Debt
(27,909
)
 
(11,009
)
 
(21,000
)
Payments for Issuance of Long-Term Debt
(63
)
 
(9
)
 
(627
)
Dividends on Common Stock

 
(40,764
)
 
(18,201
)
Additional Investment by Shareholder
65,000

 

 
25,000

Tax Deficiency from Restricted Stock Plan

 
(72
)
 
(73
)
Net Cash Provided by Financing Activities
67,928

 
61,146

 
109,999

 
 
 
 
 
 
Net Increase (Decrease) in Cash and Cash Equivalents
584

 
(1,003
)
 
(242
)
Cash and Cash Equivalents at Beginning of Period
775

 
1,778

 
2,020

 
 
 
 
 
 
Cash and Cash Equivalents at End of Period
$
1,359

 
$
775

 
$
1,778

 
 
 
 
 
 

31


 
 
 
 
 
 
Supplemental Disclosures of Cash Flow Information
 

 
 

 
 

   Cash paid during the year for:
 
 
 
 
 
     Interest (Net of Amounts Capitalized)
$
18,497

 
$
19,373

 
$
17,832

     Income Taxes (Net of Refunds)
$
(1
)
 
$
(1,665
)
 
$
(7,690
)
 
 
 
 
 
 
Supplemental Disclosures of Noncash Investing Activities
 

 
 

 
 

     Capital Expenditures acquired on account but not paid at year-end
$
25,275

 
$
24,857

 
$
17,551


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



32



SOUTH JERSEY GAS COMPANY
BALANCE SHEETS
(In Thousands)
 
 
December 31,
2016
 
December 31,
2015
Assets
 
 
 
Property, Plant and Equipment:
 
 
 
Utility Plant, at original cost
$
2,424,134

 
$
2,211,239

Accumulated Depreciation
(471,222
)
 
(440,473
)
 
 
 
 
Property, Plant and Equipment - Net
1,952,912

 
1,770,766

 
 
 
 
Investments:
 

 
 

Available-for-Sale Securities

 
8,788

Restricted Investments
32

 
6,769

 
 
 
 
Total Investments
32

 
15,557

 
 
 
 
Current Assets:
 

 
 

Cash and Cash Equivalents
1,359

 
775

Notes Receivable

 
9,916

Accounts Receivable
69,651

 
64,445

Accounts Receivable - Related Parties
1,355

 
1,972

Unbilled Revenues
41,754

 
25,613

Provision for Uncollectibles
(12,570
)
 
(9,778
)
Natural Gas in Storage, average cost
11,621

 
14,294

Materials and Supplies, average cost
914

 
937

Prepaid Taxes
16,428

 
21,483

Derivatives - Energy Related Assets
5,434

 
1,077

Other Prepayments and Current Assets
13,853

 
13,405

 
 
 
 
Total Current Assets
149,799

 
144,139

 
 
 
 
Regulatory and Other Noncurrent Assets:
 

 
 

Regulatory Assets
410,746

 
323,434

Long-Term Receivables
25,758

 
24,950

Derivatives - Energy Related Assets
373

 
64

Other
12,303

 
2,666

 
 
 
 
Total Regulatory and Other Noncurrent Assets
449,180

 
351,114

 
 
 
 
Total Assets
$
2,551,923

 
$
2,281,576

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

33


SOUTH JERSEY GAS COMPANY
BALANCE SHEETS
(In Thousands, except per share amounts)
 
 
December 31,
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
(14,934
)
 
(12,862
)
Retained Earnings
533,159

 
464,114

 
 
 
 
Total Common Equity
839,900

 
707,927

 
 
 
 
Long-Term Debt (See Note 1)
423,177

 
577,454

 
 
 
 
Total Capitalization
1,263,077

 
1,285,381

 
 
 
 
Current Liabilities:
 

 
 

Notes Payable
104,300

 
134,400

Current Portion of Long-Term Debt
215,909

 
27,909

Accounts Payable - Commodity
23,815

 
8,936

Accounts Payable - Other
45,370

 
40,579

Accounts Payable - Related Parties
11,216

 
7,552

Derivatives - Energy Related Liabilities
1,372

 
5,489

Derivatives - Other Current
386

 

Customer Deposits and Credit Balances
45,816

 
19,531

Environmental Remediation Costs
45,018

 
48,323

Taxes Accrued
855

 
1,930

Pension Benefits
2,428

 
2,227

Interest Accrued
5,369

 
5,989

Other Current Liabilities
8,011

 
5,686

 
 
 
 
Total Current Liabilities
509,865

 
308,551

 
 
 
 
Regulatory and Other Noncurrent Liabilities:
 

 
 

Regulatory Liabilities
49,121

 
42,841

Deferred Income Taxes - Net
469,408

 
432,674

Environmental Remediation Costs
108,029

 
74,871

Asset Retirement Obligations
58,674

 
57,219

Pension and Other Postretirement Benefits
81,800

 
65,491

Derivatives - Energy Related Liabilities

 
351

Derivatives - Other
6,979

 
7,631

Other
4,970

 
6,566

 
 
 
 
Total Regulatory and Other Noncurrent Liabilities
778,981

 
687,644

 
 
 
 
Commitments and Contingencies (Note 12)


 


 
 
 
 
Total Capitalization and Liabilities
$
2,551,923

 
$
2,281,576

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

34




SOUTH JERSEY GAS COMPANY
STATEMENTS OF CHANGES IN COMMON EQUITY AND COMPREHENSIVE INCOME
(In Thousands)

 
Common Stock
 
Other Paid-In Capital and Premium on Common Stock
 
Accumulated Other Comprehensive Loss
 
Retained Earnings
 
Total
Balance at January 1, 2014
$
5,848

 
$
225,972

 
$
(10,869
)
 
$
390,018

 
$
610,969

Net Income


 


 


 
66,483

 
66,483

Other Comprehensive Gain, Net of Tax: (a)
 

 
 

 
(3,610
)
 
 

 
(3,610
)
Cash Dividends Declared – Common Stock

 

 

 
(18,201
)
 
(18,201
)
Additional Investment by Shareholder

 
25,000

 

 

 
25,000

Tax Deficiency from Restricted Stock Plan

 
(73
)
 

 

 
(73
)
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2014
5,848

 
250,899

 
(14,479
)
 
438,300

 
680,568

Net Income
 
 
 
 
 
 
66,578

 
66,578

Other Comprehensive Loss, Net of Tax: (a)
 
 
 
 
1,617

 
 
 
1,617

Cash Dividends Declared – Common Stock
 
 
 
 
 
 
(40,764
)
 
(40,764
)
Additional Investment by Shareholder

 


 

 

 

Tax Deficiency from Restricted Stock Plan
 
 
(72
)
 
 
 
 
 
(72
)
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2015
5,848

 
250,827

 
(12,862
)