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10-Q
SOUTHERN CO GAS filed this Form 10-Q on 11/04/2016
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
 
þ    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2016
OR
¨  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 1-14174
 
SOUTHERN COMPANY GAS
(Exact name of registrant as specified in its charter)
 
 
Georgia
58-2210952
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
 
 
Ten Peachtree Place NE, Atlanta, Georgia 30309
(Address of principal executive offices)
 
404-584-4000
(Registrant's telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ  No ¨
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ  No ¨

 
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” ”accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer þ 
Accelerated filer ¨
Non-accelerated filer ¨
 (Do not check if a smaller reporting company)
Smaller reporting company ¨
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨  No þ 
 
 
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
 
 
Description of Common Stock
Shares Outstanding as of September 30, 2016
Par Value $0.01 Per Share
100




INDEX TO QUARTERLY REPORT ON FORM 10-Q
September 30, 2016

 
 
Page Number
 
 
 
PART I - FINANCIAL INFORMATION
 
 
 
 
Item 1.
Financial Statements (Unaudited)
 
 
 
 
 
Item 2.
Item 3.
Item 4.
 
 
 
 
 
PART II - OTHER INFORMATION
 
 
 
 
Item 1.
Item 1A.
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
Inapplicable
Item 3.
Defaults Under Senior Securities
Inapplicable
Item 4.
Mine Safety Disclosures
Inapplicable
Item 5.
Other Information
Inapplicable
Item 6.
 



DEFINITIONS
Term
Meaning
ASU
Accounting Standards Update
Atlanta Gas Light
Atlanta Gas Light Company
Atlantic Coast Pipeline
Atlantic Coast Pipeline, LLC
Central Valley
Central Valley Gas Storage, LLC
CUB
Citizens Utility Board
Dalton Pipeline
A 50% undivided ownership interest in a pipeline facility in Georgia
EPA
U.S. Environmental Protection Agency
FASB
Financial Accounting Standards Board
FERC
Federal Energy Regulatory Commission
Fitch
Fitch Ratings, Inc.
Form 10-K
Annual Report on Form 10-K of Southern Company Gas for the year ended December 31, 2015
GAAP
U.S. generally accepted accounting principles
Georgia PSC
Georgia Public Service Commission, the state regulatory agency for Atlanta Gas Light
GNG
Georgia Natural Gas Company
Golden Triangle
Golden Triangle Storage, Inc.
Heating Degree Days
A measure of weather, calculated when the average daily temperatures are less than 65 degrees Fahrenheit
Heating Season
The period from November through March when natural gas usage and operating revenues are generally higher
Horizon Pipeline
Horizon Pipeline Company, LLC
Illinois Commission
Illinois Commerce Commission, the state regulatory agency for Nicor Gas
Jefferson Island
Jefferson Island Storage & Hub, LLC
LOCOM
Lower of weighted average cost or current market price
Merger
The merger of AMS Corp., a wholly-owned, direct subsidiary of Southern Company, with and into Southern Company Gas, effective July 1, 2016, with Southern Company Gas continuing as the surviving corporation and a wholly-owned, direct subsidiary of Southern Company
mmBtu
Million British thermal units
Moody’s
Moody’s Investors Service, Inc.
New Jersey BPU
New Jersey Board of Public Utilities, the state regulatory agency for Elizabethtown Gas
Nicor Gas
Northern Illinois Gas Company, doing business as Nicor Gas Company
Nicor Gas Credit Facility
$700 million credit facility entered into by Nicor Gas to support its commercial paper program
NYMEX
New York Mercantile Exchange, Inc.
PennEast Pipeline
PennEast Pipeline Company, LLC
Piedmont
Piedmont Natural Gas Company, Inc.
Pivotal Utility Holdings
Pivotal Utility Holdings, Inc., doing business as Elizabethtown Gas, Elkton Gas and Florida City Gas
PRP
Pipeline Replacement Program, Atlanta Gas Light's 15-year infrastructure replacement program, which ended in December 2013
S&P
S&P Global Ratings, a division of S&P Global Inc.
SEC
U.S. Securities and Exchange Commission
Sequent
Sequent Energy Management, L.P.
SNG
Southern Natural Gas Company L.L.C.
Southern Company
The Southern Company
Southern Company Gas
Southern Company Gas (formerly known as AGL Resources Inc.) and its subsidiaries
Southern Company Gas Capital
Southern Company Gas Capital Corporation (formerly known as AGL Capital Corporation), a wholly-owned subsidiary of Southern Company Gas
Southern Company Gas Credit Facility
$1.3 billion credit agreement entered into by Southern Company Gas Capital to support its commercial paper program
SouthStar
SouthStar Energy Services, LLC
Triton
Triton Container Investments, LLC
VIE
Variable interest entity
Virginia Commission
Virginia State Corporation Commission, the state regulatory agency for Virginia Natural Gas
Virginia Natural Gas
Virginia Natural Gas, Inc.
WACOG
Weighted average cost of gas



CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
This Quarterly Report on Form 10-Q contains forward-looking statements. Forward-looking statements include, among other things, statements concerning regulatory matters, the strategic goals for Southern Company Gas, economic conditions, regulatory and environmental cost recovery and other rate actions, current and proposed environmental regulations and related compliance plans and estimated expenditures, pending or potential litigation matters, access to sources of capital, projections for the qualified pension plan contributions, financing activities, completion dates of construction projects, filings with state and federal regulatory authorities, and estimated other plans and expenditures. In some cases, forward-looking statements can be identified by terminology such as "may," "will," "could," "should," "expects," "plans," "anticipates," "believes," "estimates," "projects," "predicts," "potential," or "continue" or the negative of these terms or other similar terminology. There are various factors that could cause actual results to differ materially from those suggested by the forward-looking statements; accordingly, there can be no assurance that such indicated results will be realized. These factors include:
the impact of recent and future federal and state regulatory changes, including legislative and regulatory initiatives regarding deregulation and restructuring of the natural gas utility industry, environmental laws, and also changes in tax and other laws and regulations to which Southern Company Gas and its subsidiaries are subject, as well as changes in application of existing laws and regulations;
current and future litigation, regulatory investigations, proceedings, or inquiries, including, without limitation, IRS and state tax audits;
the effects, extent, and timing of the entry of additional competition in the markets in which Southern Company Gas' subsidiaries operate;
variations in demand for natural gas, including those relating to weather, the general economy and recovery from the last recession, population and business growth (and declines), the effects of energy conservation and efficiency measures, including from the development and deployment of alternative energy sources, and any potential economic impacts resulting from federal fiscal decisions;
available sources and costs of natural gas;
limits on pipeline capacity;
effects of inflation;
the ability to control costs and avoid cost overruns during the development and construction of facilities;
investment performance of Southern Company Gas' employee and retiree benefit plans;
advances in technology;
state and federal rate regulations and the impact of pending and future rate cases and negotiations, including rate actions relating to natural gas and other cost recovery mechanisms;
the ability to successfully operate the natural gas distribution and storage facilities and the successful performance of necessary corporate functions;
the inherent risks involved in transporting and storing natural gas;
the performance of the non-utility businesses and the success of efforts to invest in and develop new opportunities;
internal restructuring or other restructuring options that may be pursued;
potential business strategies, including acquisitions or dispositions of assets or businesses, which cannot be assured to be completed or beneficial to Southern Company Gas or its subsidiaries;
the possibility that the anticipated benefits from the Merger cannot be fully realized or may take longer to realize than expected, the possibility that costs related to integration with Southern Company will be greater than expected, the ability to retain and hire key personnel and maintain relationships with customers, suppliers, or other business partners, and the diversion of management time on integration related issues;
the ability of counterparties of Southern Company Gas and its subsidiaries to make payments as and when due and to perform as required;
the direct or indirect effect on Southern Company Gas' business resulting from cyber intrusion or terrorist incidents and the threat of terrorist incidents;
interest rate fluctuations and financial market conditions and the results of financing efforts;
changes in Southern Company Gas' and any of its subsidiaries' credit ratings, including impacts on interest rates, access to capital markets, and collateral requirements;
the impacts of any sovereign financial issues, including impacts on interest rates, access to capital markets, impacts on currency exchange rates, counterparty performance, and the economy in general;
catastrophic events such as fires, earthquakes, explosions, floods, hurricanes and other storms, droughts, pandemic health events such as influenzas, or other similar occurrences;
the direct or indirect effects on Southern Company Gas' business resulting from incidents affecting the U.S. natural gas pipeline infrastructure or operation of storage resources;
the effect of accounting pronouncements issued periodically by standard-setting bodies; and
the other factors discussed elsewhere herein and in other reports (including the Form 10-K) filed by Southern Company Gas from time to time with the SEC.
Southern Company Gas expressly disclaims any obligation to update or revise any forward-looking statements.





SOUTHERN COMPANY GAS AND SUBSIDIARY COMPANIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
 
 
Successor
 
 
Predecessor
 
Successor
 
 
Predecessor
 
 
For the Three Months Ended September 30, 2016
 
 
For the Three Months Ended September 30, 2015
 
July 1, 2016 through September 30, 2016
 
 
January 1, 2016 through June 30, 2016
 
For the Nine Months Ended September 30, 2015
 
 
(in millions)
 
 
(in millions)
 
(in millions)
 
 
(in millions)
Operating Revenues:
 
 
 
 
 
 
 
 
 
 
 
 
Natural gas revenues (includes revenue
taxes of $9, $9, $9, $57, and $83 for
the periods presented, respectively)
 
$
518

 
 
$
553

 
$
518

 
 
$
1,841

 
$
2,887

Other revenues
 
25

 
 
31

 
25

 
 
64

 
92

Total operating revenues
 
543

 
 
584

 
543

 
 
1,905

 
2,979

Operating Expenses:
 
 

 
 
 

 
 
 
 
 

 
 

Cost of natural gas
 
133

 
 
140

 
133

 
 
755

 
1,282

Cost of other sales
 
2

 
 
6

 
2

 
 
14

 
21

Other operations and maintenance
 
216

 
 
218

 
216

 
 
454

 
676

Depreciation and amortization
 
116

 
 
98

 
116

 
 
206

 
293

Taxes other than income taxes
 
29

 
 
28

 
29

 
 
99

 
142

Merger-related expenses
 
35

 
 
35

 
35

 
 
56

 
35

Total operating expenses
 
531

 
 
525

 
531

 
 
1,584

 
2,449

Operating Income
 
12

 
 
59

 
12

 
 
321

 
530

Other Income and (Expense):
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for equity funds used during
construction
 

 
 
1

 

 
 
2

 
3

Interest expense, net of amounts
capitalized
 
(39
)
 
 
(43
)
 
(39
)
 
 
(96
)
 
(129
)
Earnings from equity method
investments
 
29

 
 
2

 
29

 
 
2

 
4

Other income (expense), net
 
9

 
 

 
9

 
 
3

 
3

Total other income and (expense)
 
(1
)
 
 
(40
)
 
(1
)
 
 
(89
)
 
(119
)
Earnings Before Income Taxes
 
11

 
 
19

 
11

 
 
232

 
411

Income taxes
 
7

 
 
7

 
7

 
 
87

 
150

Consolidated Net Income
 
4

 
 
12

 
4

 
 
145

 
261

Less: Net income attributable to
noncontrolling interest
 

 
 
1

 

 
 
14

 
15

Consolidated Net Income Attributable
to Southern Company Gas
 
$
4

 
 
$
11

 
$
4

 
 
$
131

 
$
246


The accompanying notes are an integral part of these condensed consolidated financial statements.



SOUTHERN COMPANY GAS AND SUBSIDIARY COMPANIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
 
 
Successor
 
 
Predecessor
 
Successor
 
 
Predecessor
 
 
For The Three Months Ended September 30, 2016
 
 
For The Three Months Ended September 30, 2015
 
July 1, 2016 through September 30, 2016
 
 
January 1, 2016 through June 30, 2016
 
For The Nine Months Ended September 30, 2015
 
 
(in millions)
 
 
(in millions)
 
(in millions)
 
 
(in millions)
Consolidated Net Income
 
$
4

 
 
$
12

 
$
4

 
 
$
145

 
$
261

Other comprehensive income (loss):
 
 

 
 
 

 
 
 
 
 

 
 

Qualifying hedges:
 
 

 
 
 

 
 
 
 
 

 
 

Changes in fair value, net of tax of $(2),
$(18), $(2), $(23) and $(1), respectively
 
(3
)
 
 
(30
)
 
(3
)
 
 
(41
)
 
(3
)
Reclassification adjustment for amounts
included in net income, net of tax of less than
$1 for each period presented
 

 
 
1

 

 
 
1

 
5

Pension and other post retirement benefit plans:
 
 
 
 
 

 
 
 
 
 

 
 

Reclassification adjustment for amounts
included in net income, net of tax of
$0, $2,
$0, $
4 and $6, respectively
 

 
 
2

 

 
 
5

 
9

Total other comprehensive income (loss)
 
(3
)
 
 
(27
)
 
(3
)
 
 
(35
)
 
11

Less: Comprehensive income attributable to
noncontrolling interest
 

 
 

 

 
 
14

 
15

Consolidated Comprehensive Income (Loss)
Attributable to Southern Company Gas
 
$
1

 
 
$
(15
)
 
$
1

 
 
$
96

 
$
257


The accompanying notes are an integral part of these condensed consolidated financial statements.




SOUTHERN COMPANY GAS AND SUBSIDIARY COMPANIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
 
 
Successor
 
 
Predecessor
 
 
July 1, 2016 through September 30, 2016
 
 
January 1, 2016 through June 30, 2016
 
For the Nine Months Ended September 30, 2015
 
 
(in millions)
 
 
(in millions)
Operating Activities:
 
 
 
 
 
 
 
Consolidated net income
 
$
4

 
 
$
145

 
$
261

Adjustments to reconcile consolidated net income to net
cash provided from operating activities —
 
 
 
 
 

 
 

Depreciation and amortization, total
 
116

 
 
206

 
293

Deferred income taxes
 
(30
)
 
 
8

 
38

Stock based compensation expense
 
11

 
 
20

 
22

Hedge settlements
 
(35
)
 
 
(26
)
 

Pension, postretirement, and other employee benefits
 
(123
)
 
 
5

 
18

Goodwill impairment
 

 
 

 
14

Other, net
 
(30
)
 
 
80

 
117

Changes in certain current assets and liabilities —
 
 
 
 
 

 
 

-Receivables
 
(18
)
 
 
181

 
761

-Natural gas for sale
 
(222
)
 
 
273

 
62

-Other current assets
 
(35
)
 
 
188

 
168

-Accounts payable
 
78

 
 
43

 
(313
)
-Accrued taxes
 
(11
)
 
 
41

 
(19
)
-Accrued compensation
 
(36
)
 
 
(21
)
 
(20
)
-Other current liabilities
 
(11
)
 
 
(30
)
 
8

Net cash provided from (used for) operating activities
 
(342
)
 
 
1,113

 
1,410

Investing Activities:
 
 
 
 
 

 
 

Property additions
 
(287
)
 
 
(509
)
 
(677
)
Cost of removal, net of salvage
 
(21
)
 
 
(32
)
 
(68
)
Change in construction payables, net
 
9

 
 
(7
)
 

Investment in unconsolidated subsidiaries
 
(1,421
)
 
 
(14
)
 
(8
)
Returned investment in unconsolidated subsidiaries
 
2

 
 
3

 
11

Other investing activities
 
3

 
 

 
1

Net cash used for investing activities
 
(1,715
)
 
 
(559
)
 
(741
)
Financing Activities:
 
 
 
 
 

 
 

Increase (decrease) in notes payable, net
 
472

 
 
(896
)
 
(289
)
Proceeds —
 
 
 
 
 
 
 
First mortgage bonds
 

 
 
250

 

Senior notes
 
900

 
 
350

 

Capital contributions from parent company
 
1,089

 
 

 

Redemptions and repurchases —
 
 
 
 
 
 
 
First mortgage bonds
 

 
 
(125
)
 

Senior notes
 
(300
)
 
 

 
(200
)
Distribution to noncontrolling interest
 

 
 
(19
)
 
(18
)
Payment of common stock dividends
 
(63
)
 
 
(128
)
 
(183
)
Other financing activities
 
(8
)
 
 
10

 
9

Net cash provided from (used for) financing activities
 
2,090

 
 
(558
)
 
(681
)
Net Change in Cash and Cash Equivalents
 
33

 
 
(4
)
 
(12
)
Cash and Cash Equivalents at Beginning of Period
 
15

 
 
19

 
31

Cash and Cash Equivalents at End of Period
 
$
48

 
 
$
15

 
$
19

Supplemental Cash Flow Information:
 
 
 
 
 
 
 
Cash paid (received) during the period for —
 
 
 
 
 

 
 

Interest (net of $2, $3, and $3 capitalized,
respectively)
 
$
86

 
 
$
119

 
$
145

Income taxes, net
 
54

 
 
(100
)
 
(26
)
Noncash transactions — Accrued property additions at
end of period
 
50

 
 
41

 
31

The accompanying notes are an integral part of these condensed consolidated financial statements.



SOUTHERN COMPANY GAS AND SUBSIDIARY COMPANIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
 
 
Successor
 
 
Predecessor
Assets
 
At September 30, 2016
 
 
At December 31, 2015
 
 
(in millions)
 
 
(in millions)
Current Assets:
 
 
 
 
 
Cash and cash equivalents
 
$
48

 
 
$
19

Receivables —
 
 

 
 
 

Energy marketing receivable
 
526

 
 
445

Customer accounts receivable
 
190

 
 
316

Unbilled revenues
 
63

 
 
140

Other accounts and notes receivable
 
55

 
 
68

Accumulated provision for uncollectible accounts
 
(29
)
 
 
(29
)
Materials and supplies
 
27

 
 
29

Natural gas for sale
 
627

 
 
622

Assets from risk management activities, net of collateral
 
98

 
 
206

Prepaid expenses
 
76

 
 
218

Other regulatory assets, current
 
69

 
 
68

Other current assets
 
9

 
 
13

Total current assets
 
1,759

 
 
2,115

Property, Plant, and Equipment:
 
 

 
 
 

In service
 
14,267

 
 
12,152

Less accumulated depreciation
 
4,384

 
 
2,775

Plant in service, net of depreciation
 
9,883

 
 
9,377

Construction work in progress
 
434

 
 
414

Total property, plant, and equipment
 
10,317

 
 
9,791

Other Property and Investments:
 
 
 
 
 
Goodwill
 
5,937

 
 
1,813

Other intangible assets, net of amortization of $20 and $68 at September 30,
2016 and December 31, 2015, respectively
 
380

 
 
109

Equity investments in unconsolidated subsidiaries
 
1,531

 
 
80

Miscellaneous property and investments
 
22

 
 
23

Total other property and investments
 
7,870

 
 
2,025

Deferred Charges and Other Assets:
 
 
 
 
 
Other regulatory assets, deferred
 
1,105

 
 
670

Other deferred charges and assets
 
134

 
 
153

Total deferred charges and other assets
 
1,239

 
 
823

Total Assets
 
$
21,185

 
 
$
14,754


The accompanying notes are an integral part of these condensed consolidated financial statements.





SOUTHERN COMPANY GAS AND SUBSIDIARY COMPANIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
 
 
Successor
 
 
Predecessor
Liabilities and Stockholders' Equity
 
At September 30, 2016
 
 
At December 31, 2015
 
 
(in millions)
 
 
(in millions)
Current Liabilities:
 
 
 
 
 
Securities due within one year
 
$
142

 
 
$
545

Notes payable
 
586

 
 
1,010

Energy marketing trade payables
 
533

 
 
418

Accounts payable
 
276

 
 
255

Customer deposits
 
172

 
 
165

Accrued taxes —
 
 
 
 
 
Accrued income taxes
 
29

 
 
13

Other accrued taxes
 
60

 
 
46

Accrued interest
 
46

 
 
49

Accrued compensation
 
35

 
 
92

Liabilities from risk management activities, net of collateral
 
47

 
 
44

Other regulatory liabilities, current
 
62

 
 
81

Accrued environmental remediation liabilities, current
 
59

 
 
67

Mandatorily redeemable noncontrolling interest
 
174

 
 

Other current liabilities
 
100

 
 
133

Total current liabilities
 
2,321

 
 
2,918

Long-term Debt
 
5,272

 
 
3,275

Deferred Credits and Other Liabilities:
 
 
 
 
 
Accumulated deferred income taxes
 
1,900

 
 
1,943

Accumulated deferred investment tax credits
 
19

 
 
20

Employee benefit obligations
 
564

 
 
515

Other cost of removal obligations
 
1,609

 
 
1,591

Other regulatory liabilities, deferred
 
51

 
 
53

Accrued environmental remediation liabilities, deferred
 
374

 
 
364

Other deferred credits and liabilities
 
40

 
 
100

Total deferred credits and other liabilities
 
4,557

 
 
4,586

Total Liabilities
 
12,150

 
 
10,779

Common Stockholders' Equity:
 
 

 
 
 

Common stock — September 30, 2016: par value $0.01 per share
— December 31, 2015: par value $5 per share
 
 
 
 
 
Authorized — September 30, 2016: 100 million shares
— December 31, 2015: 750 million shares
 
 
 
 
 
Outstanding — September 30, 2016: 100 shares
— December 31, 2015: 120.4 million shares
 
 
 
 
 
Treasury — September 30, 2016: no shares
— December 31, 2015: 0.2 million shares
 
 
 
 
 
Par Value
 

 
 
603

Paid-in capital
 
9,097

 
 
2,099

Treasury, at cost
 

 
 
(8
)
Retained earnings (accumulated deficit)
 
(59
)
 
 
1,421

Accumulated other comprehensive loss
 
(3
)
 
 
(186
)
Total Common Stockholders’ Equity
 
9,035

 
 
3,929

Noncontrolling Interest
 

 
 
46

Total Stockholders' Equity
 
9,035

 
 
3,975

Total Liabilities and Stockholders' Equity
 
$
21,185

 
 
$
14,754


The accompanying notes are an integral part of these condensed consolidated financial statements.



SOUTHERN COMPANY GAS AND SUBSIDIARY COMPANIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THIRD QUARTER 2016 vs. THIRD QUARTER 2015
AND
COMBINED YEAR-TO-DATE 2016 vs. YEAR-TO-DATE 2015
OVERVIEW
Southern Company Gas (formerly known as AGL Resources Inc.) is an energy services holding company whose primary business is the safe, reliable, and cost-effective distribution of natural gas in seven states – Illinois, Georgia, Virginia, New Jersey, Florida, Tennessee, and Maryland – through seven utilities. Southern Company Gas is also involved in several other complementary businesses.
In conjunction with the Merger, Southern Company Gas changed the names of its reportable segments to better align with its new parent company. Southern Company Gas has four reportable segments – gas distribution operations (formerly referred to as distribution operations), gas marketing services (formerly referred to as retail operations), wholesale gas services (formerly referred to as wholesale services), and gas midstream operations (formerly referred to as midstream operations) – and one non-reportable segment – other. For additional information on these reportable segments, see Note (J) to the Condensed Consolidated Financial Statements herein and "Business" of Southern Company Gas in Item 1 of the Form 10-K.
Many factors affect the opportunities, challenges, and risks of Southern Company Gas' business. These factors include the ability to maintain a constructive regulatory environment, to maintain and grow natural gas sales, and to effectively manage and secure timely recovery of costs. Southern Company Gas has various regulatory mechanisms that operate to address cost recovery.
Southern Company Gas' operating results can vary significantly from quarter to quarter due to seasonal fluctuations in natural gas sales and other factors. Operating results for the interim periods presented are not necessarily indicative of the results to be expected for the full fiscal period. During the Heating Season, natural gas usage and operating revenues are generally higher, as more customers are connected to the gas distribution systems and natural gas usage is higher in periods of colder weather. Alternatively, Southern Company Gas' base operating expenses, excluding cost of natural gas, revenue taxes, and certain incentive compensation costs, are incurred relatively evenly over any given year, resulting in variability in the quarterly pattern of earnings.
Merger With Southern Company
On July 1, 2016, Southern Company Gas completed the Merger, which was accounted for by Southern Company using the acquisition method of accounting whereby the assets acquired and liabilities assumed were recognized at fair value as of the acquisition date. Pushdown accounting was applied to Southern Company Gas, which created a new cost basis assigned to assets, liabilities, and equity as of the acquisition date. Accordingly, the successor financial statements reflect a new basis of accounting and successor and predecessor period financial results (separated by a heavy black line) are presented, but are not comparable.
In order to present MANAGEMENT'S DISCUSSION AND ANALYSIS in a way that offers users a meaningful period-to-period comparison, the RESULTS OF OPERATIONS and FINANCIAL CONDITION AND LIQUIDITY reported herein include disclosure of the combined successor and predecessor results of operations and cash flows. The combined data consists of predecessor information for the period January 1, 2016 through June 30, 2016 and successor information for the period July 1, 2016 through September 30, 2016. The combined presentation is considered a non-GAAP disclosure. Southern Company Gas has included such disclosure to facilitate the comparison of the operating and financial performance for the nine months ended September 30, 2016 to the comparable period in 2015, as the core operations of Southern Company Gas have not changed as a result of the Merger. The combined information does not purport to represent what Southern Company Gas' consolidated results of operations would have been if the successor had actually been formed on January 1, 2016, nor has Southern Company Gas made any attempt to either include or exclude expenses or income that would have resulted had the acquisition actually occurred on January 1, 2016.
Southern Company Gas' results for the successor period July 1, 2016 through September 30, 2016 and combined year-to-date 2016 include a $17 million decrease in net income due to pushdown accounting that is comprised of reduced revenues and increased amortization expense, partially offset by lower interest expense, all of which is a result of the new basis of assets and liabilities to reflect their fair values.
In the third quarter and combined year-to-date 2016, Merger-related expenses were $35 million and $91 million, respectively, compared to $35 million for each of the corresponding periods in 2015. See RESULTS OF OPERATIONS herein for information related to Merger-related expenses. Also, see Note (I) to the Condensed Consolidated Financial Statements herein for additional information relating to the Merger.


MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Investment in SNG
On September 1, 2016, Southern Company Gas paid approximately $1.4 billion to acquire a 50% equity interest in SNG, which is the owner of a 7,000-mile pipeline system connecting natural gas supply basins in Texas, Louisiana, Mississippi, and Alabama to markets in Louisiana, Mississippi, Alabama, Florida, Georgia, South Carolina, and Tennessee. The investment in SNG is accounted for using the equity method. Southern Company Gas recorded pre-tax earnings of $27 million ($16 million, net of tax) from this investment in September 2016. See Notes (I) and (K) to the Condensed Consolidated Financial Statements herein for additional information.
Other Matters
On February 12, 2016, Southern Company Gas entered into an agreement with Piedmont to purchase its 15% interest in SouthStar for $160 million. This transaction was contingent upon the closing of the merger between Piedmont and Duke Energy Corporation, which occurred on October 3, 2016. On the same day, Southern Company Gas completed its purchase of Piedmont's interest in SouthStar. Beginning in the fourth quarter 2016 SouthStar will be fully consolidated with Southern Company Gas. See Note (K) to the Condensed Consolidated Financial Statements herein for additional information.
Performance and Non-GAAP Measures
Southern Company Gas evaluates segment performance using the measures of earnings before interest and taxes (EBIT) and operating margin. EBIT includes operating income and other income and (expense) and excludes interest expense, net of amounts capitalized and income taxes, which Southern Company Gas evaluates on a consolidated basis. Southern Company Gas uses EBIT herein to discuss the results of its segments, as EBIT is the primary measure of segment profit or loss; however, the use of consolidated EBIT herein is considered a non-GAAP measure. Southern Company Gas believes the presentation of consolidated EBIT provides useful information regarding a consolidated measure of profit or loss. The reconciliation of consolidated EBIT to consolidated net income attributable to Southern Company Gas under GAAP is provided within RESULTS OF OPERATIONS – "Combined Operating Results" herein.
Operating margin is a non-GAAP measure that is calculated as operating revenues minus cost of natural gas, cost of other sales, and revenue tax expense. Operating margin excludes other operations and maintenance expenses, depreciation and amortization, taxes other than income taxes, and Merger-related expenses, which are included in the calculation of operating income as calculated in accordance with GAAP and reflected in the Condensed Consolidated Statements of Income. Southern Company Gas believes that the presentation of operating margin provides useful information regarding the contribution resulting from customer growth in the gas distribution operations segment since the cost of natural gas and revenue tax expense can vary significantly and are generally billed directly to customers. Southern Company Gas further believes that operating margin at the gas marketing services, wholesale gas services, and gas midstream operations segments allows it to focus on a direct measure of operating margin before overhead costs.
Consolidated EBIT and operating margin should not be considered alternatives to, or more meaningful indicators of, Southern Company Gas' operating performance than consolidated net income attributable to Southern Company Gas or operating income as determined in accordance with GAAP. In addition, Southern Company Gas' operating margin may not be comparable to similarly titled measures of other companies.
Operating Metrics
Southern Company Gas continues to focus on several operating metrics, which include Heating Degree Days, customer count, volumes of natural gas sold, and natural gas capacity under firm subscription. For additional information on these indicators, see Results of Operations – "Operating Metrics" of Southern Company Gas in Item 7 of the Form 10-K.
Heating Degree Days
Southern Company Gas measures weather and the effect on its business using Heating Degree Days. With the exception of Southern Company Gas' utilities in Illinois and Florida, Southern Company Gas has various regulatory mechanisms, such as weather normalization mechanisms, which limit its exposure to weather changes within typical ranges in each of its utilities' respective service areas. However, the utility customers in Illinois and the gas marketing services customers primarily in Georgia can be impacted by warmer- or colder-than-normal weather. The following table presents the Heating Degree Days information for those locations.
 
 
Year-to-Date
 
2016 vs. 2015
 
2016 vs. normal
 
 
Normal (a)
 
2016
 
2015
 
warmer
 
warmer
Illinois (b)
 
3,816

 
3,353

 
3,918

 
(14
)%
 
(12
)%
Georgia
 
1,639

 
1,449

 
1,654

 
(12
)%
 
(12
)%
(a)
Normal represents the 10-year average from January 1, 2006 through September 30, 2015 for Illinois at Chicago Midway International Airport and for Georgia at Atlanta Hartsfield-Jackson International Airport, based on information obtained from the National Oceanic and Atmospheric Administration, National Climatic Data Center.
(b)
The 10-year average Heating Degree Days established by the Illinois Commission in Nicor Gas' last rate case is 3,580 for the first nine months from 1998 through 2007.


MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Weather did not have a significant impact on Southern Company Gas' consolidated EBIT during the third quarter 2016 and 2015. For combined year-to-date 2016, the unfavorable EBIT impact from the warmer-than-normal weather was $8 million, net of the impact of weather hedging, compared to an $11 million favorable weather impact for the corresponding period in 2015, when weather was significantly colder than normal.
Customer Count
The number of customers at gas distribution operations and energy customers at gas marketing services can be impacted by natural gas prices, economic conditions, and competition from alternative fuels. The customer metrics presented in the following table highlight the average number of customers to which Southern Company Gas provided services for the specified periods.
 
 
Third Quarter
 
2016 vs. 2015
 
Year-to-Date
 
2016 vs. 2015
 
 
2016
 
2015
 
% change
 
2016
 
2015
 
% change
 
 
(in thousands)
 
 
 
(in thousands)
 
 
Gas distribution operations
 
4,525

 
4,488

 
0.8
 %
 
4,559

 
4,526

 
0.7
 %
Gas marketing services
 
 

 
 

 
 
 
 

 
 

 
 

Energy customers
 
626

 
642

 
(2.5
)%
 
642

 
646

 
(0.6
)%
Service contracts
 
1,191

 
1,164

 
2.3
 %
 
1,198

 
1,159

 
3.4
 %
Market share of energy customers in Georgia
 
29.4
%
 
29.7
%
 
 
 
29.3
%
 
29.8
%
 
 
Southern Company Gas anticipates overall customer growth trends at gas distribution operations for 2016 to continue improving based on an expectation of continued improvement in the new housing market and low natural gas prices.
Gas marketing services' market share in Georgia has decreased slightly primarily as a result of a highly competitive marketing environment, which Southern Company Gas expects for the foreseeable future. Southern Company Gas will continue efforts in its gas marketing services segment to enter into targeted markets and expand its energy customers and service contracts.
Volumes of Natural Gas Sold
Southern Company Gas' natural gas volume metrics for gas distribution operations and gas marketing services, as shown in the following table, illustrate the effects of weather and customer demand for natural gas compared to the prior year. Wholesale gas services’ physical sales volumes represent the daily average natural gas volumes sold to customers.
 
 
Third Quarter
 
2016 vs. 2015
 
Year-to-Date
 
2016 vs. 2015
 
 
2016
 
2015
 
% change
 
2016
 
2015
 
% change
Gas distribution operations (mmBtu in millions)
 
 
 
 
 
 
 
 
 
 
 
 
Firm
 
71

 
75

 
(5.3
)%
 
467

 
519

 
(10.0
)%
Interruptible
 
22

 
23

 
(4.3
)
 
71

 
74

 
(4.1
)
Total
 
93

 
98

 
(5.1
)%
 
538

 
593

 
(9.3
)%
Gas marketing services (mmBtu in millions)
 
 

 
 

 
 

 
 

 
 

 
 

Firm:
 
 
 
 
 
 
 
 
 
 
 
 
Georgia
 
3

 
4

 
(25.0
)%
 
25

 
27

 
(7.4
)%
Illinois
 
1

 
1

 

 
8

 
10

 
(20.0
)
Other emerging markets
 
2

 
1

 
100.0

 
9

 
8

 
12.5

Interruptible:
 
 
 
 
 
 
 
 
 
 
 
 
Large commercial and industrial
 
3

 
3

 

 
10

 
11

 
(9.1
)
Total
 
9

 
9

 
 %
 
52

 
56

 
(7.1
)%
Wholesale gas services
 
 

 
 

 
 

 
 

 
 

 
 

Daily physical sales (mmBtu in millions/day)
 
7.6

 
6.4

 
18.8
 %
 
7.6

 
6.7

 
13.4
 %
Natural Gas Capacity Under Firm Subscription
Within gas midstream operations, Southern Company Gas' natural gas storage business seeks to have a significant portion of its working natural gas capacity under firm subscription, but also takes into account current and expected market conditions. The prices for natural gas storage capacity have increased in 2016 relative to the last few years, which is expected to continue as supply and demand quantities reach equilibrium with sustained economic improvement, expected exports of liquefied natural gas, and projected demand increases in response to low prices and expanded uses for natural gas. The following table illustrates the overall monthly average firm subscription rates per storage facility and the amount of firm capacity subscription for the periods presented. The amounts shown exclude 2.8 million mmBtu contracted by Sequent at September 30, 2016, at an average monthly rate of $0.054 and 5.0 million mmBtu contracted by Sequent at September 30, 2015, at an average monthly rate of $0.080.


MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 
 
September 30, 2016
 
September 30, 2015
 
 
Average rates
 
Firm capacity under subscription
 
Average rates
 
Firm capacity under subscription
 
 
(per dekatherm)
 
(mmBtu in millions)
 
(per dekatherm)
 
(mmBtu in millions)
Jefferson Island
 
$
0.103

 
2.2

 
$
0.092

 
4.2

Golden Triangle
 
0.059

 
4.8

 
0.041

 
5.0

Central Valley
 
0.058

 
2.5

 
0.047

 
4.0

RESULTS OF OPERATIONS
Combined Operating Results
The results reported herein include disclosure of the combined successor and predecessor results of operations. The combined data consists of predecessor information for the period January 1, 2016 through June 30, 2016 and successor information for the period July 1, 2016 through September 30, 2016. See OVERVIEW – "Merger With Southern Company" herein for additional information.
Results for combined year-to-date 2016 reflect certain Merger-related expenses, which are not expected to have a continuing impact on the results going forward, and those amounts are discussed in the results below.


MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Southern Company Gas' results of operations for the successor third quarter 2016, combined year-to-date 2016, and the predecessor third quarter and year-to-date 2015 are as follows:
 
 
Successor
 
 
Predecessor
 
Combined
 
 
Predecessor
 
 
Third Quarter 2016
 
 
Third Quarter 2015
 
Year-to-Date 2016
 
 
Year-to-Date 2015
 
 
(in millions)
 
 
(in millions)
 
 
(in millions)
Operating Revenues:
 
 
 
 
 
 
 
 
 
 
Natural gas revenues
 
$
518

 
 
$
553

 
$
2,359

 
 
$
2,887

Other revenues
 
25

 
 
31

 
89

 
 
92

Total operating revenues
 
543

 
 
584

 
2,448

 
 
2,979

Cost of natural gas
 
133

 
 
140

 
888

 
 
1,282

Cost of other sales
 
2

 
 
6

 
16

 
 
21

Total cost of sales
 
135

 
 
146

 
904

 
 
1,303

Revenue tax expense (*)
 
(8
)
 
 
(8
)
 
(64
)
 
 
(81
)
Operating Margin
 
400

 
 
430

 
1,480

 
 
1,595

Other Operating Expenses:
 
 
 
 
 
 
 
 
 
 
Other operations and maintenance
 
216

 
 
218

 
670

 
 
676

Depreciation and amortization
 
116

 
 
98

 
322

 
 
293

Taxes other than income taxes
 
29

 
 
28

 
128

 
 
142

Merger-related expenses
 
35

 
 
35

 
91

 
 
35

Revenue tax expense (*)
 
(8
)
 
 
(8
)
 
(64
)
 
 
(81
)
Total other operating expenses
 
388

 
 
371

 
1,147

 
 
1,065

Operating Income
 
12

 
 
59

 
333

 
 
530

Other Income and (Expense):
 
 
 
 
 
 
 
 
 
 
Allowance for equity funds used
   during construction
 

 
 
1

 
2

 
 
3

Earnings from equity method
investments
 
29

 
 
2

 
31

 
 
4

Other income (expense), net
 
9

 
 

 
12

 
 
3

Total other income and (expense)
 
38

 
 
3

 
45

 
 
10

EBIT
 
50

 
 
62

 
378

 
 
540

Interest expense, net of amounts
capitalized
 
(39
)
 
 
(43
)
 
(135
)
 
 
(129
)
Earnings Before Income Taxes
 
11

 
 
19

 
243

 
 
411

Income taxes
 
7

 
 
7

 
94

 
 
150

Consolidated Net Income
 
4

 
 
12

 
149

 
 
261

Less: Net income attributable to
noncontrolling interest
 

 
 
1

 
14

 
 
15

Consolidated Net Income
   Attributable to Southern
   Company Gas
 
$
4

 
 
$
11

 
$
135

 
 
$
246

(*)
Adjusted for Nicor Gas' revenue tax expenses, which are passed through directly to customers.
Net Income
Third Quarter 2016 vs. Third Quarter 2015
 
Combined Year-to-Date 2016 vs. Year-to-Date 2015
(change in millions)
 
(% change)
 
(change in millions)
 
(% change)
$(7)
 
(63.6)%
 
$(111)
 
(45.1)%
Consolidated net income attributable to Southern Company Gas was $4 million for the third quarter 2016 compared to $11 million for the third quarter 2015. The decrease was primarily due to purchase accounting adjustments of $17 million, lower wholesale gas services earnings, net of purchase accounting adjustments, of $8 million due largely to lower net mark-to-market hedge gains, and the income tax effect of certain non-deductible expenses associated with the Merger of $3 million, partially offset by earnings from the equity investment in SNG of $16 million and a $9 million goodwill impairment charge recorded in 2015.


MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

For combined year-to-date 2016, consolidated net income attributable to Southern Company Gas was $135 million compared to $246 million for the corresponding period in 2015. The decrease was primarily due to lower wholesale gas services earnings, net of purchase accounting adjustments, of $80 million due largely to lower commercial activity and net mark-to-market hedge losses, higher Merger-related expenses of $44 million, and purchase accounting adjustments of $17 million, partially offset by earnings from the equity investment in SNG of $16 million and a $9 million goodwill impairment charge recorded in 2015.
See Note (I) to the Condensed Consolidated Financial Statements herein for additional information regarding the Merger.
Natural Gas Revenues
Third Quarter 2016 vs. Third Quarter 2015
 
Combined Year-to-Date 2016 vs. Year-to-Date 2015
(change in millions)
 
(% change)
 
(change in millions)
 
(% change)
$(35)
 
(6.3)%
 
$(528)
 
(18.3)%
In the third quarter 2016, natural gas revenues were $518 million compared to $553 million for the corresponding period in 2015. The decrease was primarily due to lower revenues at wholesale gas services of $42 million as a result of purchase accounting adjustments and lower mark-to-market hedge gains on storage and transportation derivatives, and lower cost of gas recovered of $7 million, partially offset by higher revenues from infrastructure programs of $19 million.
For combined year-to-date 2016, natural gas revenues were $2.36 billion compared to $2.89 billion for the corresponding period in 2015. The decrease was primarily due to lower cost of gas recovered of $394 million and lower revenues at wholesale gas services of $168 million as a result of mark-to-market hedge losses on storage and transportation derivatives, lower commercial activity, and purchase accounting adjustments, partially offset by higher revenues from infrastructure programs of $55 million.
Cost of Natural Gas
Third Quarter 2016 vs. Third Quarter 2015
 
Combined Year-to-Date 2016 vs. Year-to-Date 2015
(change in millions)
 
(% change)
 
(change in millions)
 
(% change)
$(7)
 
(5.0)%
 
$(394)
 
(30.7)%
In the third quarter 2016, cost of natural gas was $133 million compared to $140 million for the corresponding period in 2015. For combined year-to-date 2016, cost of natural gas was $888 million compared to $1.28 billion for the corresponding period in 2015. The decreases were primarily due to lower demand for natural gas driven by warmer weather compared to the prior year.
Other Operations and Maintenance Expenses
Third Quarter 2016 vs. Third Quarter 2015
 
Combined Year-to-Date 2016 vs. Year-to-Date 2015
(change in millions)
 
(% change)
 
(change in millions)
 
(% change)
$(2)
 
(0.9)%
 
$(6)
 
(0.9)%
In the third quarter 2016, other operations and maintenance expenses were $216 million compared to $218 million for the corresponding period in 2015. The decrease was primarily due to a $14 million goodwill impairment charge in the third quarter 2015, partially offset by a $5 million increase related to certain compensation arrangements, including pension, and a $5 million increase in pipeline compliance and maintenance costs.
For combined year-to-date 2016, other operations and maintenance expenses were $670 million compared to $676 million for the corresponding period in 2015. The decrease was primarily due to a $14 million goodwill impairment charge in the third quarter 2015 and a $4 million decrease in legal costs, partially offset by a $12 million increase in pipeline compliance and maintenance costs.
See Note (F) to the Condensed Consolidated Financial Statements herein for additional information regarding pension costs.
Depreciation and Amortization
Third Quarter 2016 vs. Third Quarter 2015
 
Combined Year-to-Date 2016 vs. Year-to-Date 2015
(change in millions)
 
(% change)
 
(change in millions)
 
(% change)
$18
 
18.4%
 
$29
 
9.9%
In the third quarter 2016, depreciation and amortization was $116 million compared to $98 million for the corresponding period in 2015. The increase was primarily due to $11 million of additional amortization due to purchase accounting adjustments and $7 million of depreciation related to additional assets placed in service at gas distribution operations.
For combined year-to-date 2016, depreciation and amortization was $322 million compared to $293 million for the corresponding period in 2015. The increase was primarily due to $20 million of depreciation related to additional assets placed in service at gas distribution operations and $11 million of additional amortization due to purchase accounting adjustments.


MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Merger-Related Expenses
Third Quarter 2016 vs. Third Quarter 2015
 
Combined Year-to-Date 2016 vs. Year-to-Date 2015
(change in millions)
 
(% change)
 
(change in millions)
 
(% change)
$—
 
—%
 
$56
 
160.0%
In the third quarter 2016 and 2015, Merger-related expenses were $35 million. For combined year-to-date 2016, Merger-related expenses were $91 million compared to $35 million in the corresponding period in 2015. Merger-related expenses in 2016 include $18 million in rate credits provided to Elizabethtown Gas customers during the third quarter 2016 as a condition of the Merger. Additional transaction costs for the third quarter and combined year-to-date 2016 include $2 million and $33 million, respectively, for financial advisory fees, legal expenses, and other Merger-related costs, and $15 million and $40 million, respectively, for additional compensation-related expenses, including accelerated vesting of share-based compensation expenses and change in control compensation charges.
See Note (I) to the Condensed Consolidated Financial Statements herein for additional information relating to the Merger.
Interest Expense, Net of Amounts Capitalized
Third Quarter 2016 vs. Third Quarter 2015
 
Combined Year-to-Date 2016 vs. Year-to-Date 2015
(change in millions)
 
(% change)
 
(change in millions)
 
(% change)
$(4)
 
(9.3)%
 
$6
 
4.7%
In the third quarter 2016, interest expense, net of amounts capitalized was $39 million compared to $43 million for the corresponding period in 2015. The decrease was primarily due to the impact of pushdown accounting to fair value long-term debt of $10 million, partially offset by higher interest expense of $5 million as a result of new debt issuances.
For combined year-to-date 2016, interest expense, net of amounts capitalized was $135 million compared to $129 million for the corresponding period in 2015. The increase was primarily due to debt issuances in late 2015 and in 2016, net of repayments, of $11 million and an increase in regulatory infrastructure program expenses of $4 million as Southern Company Gas expensed previously deferred interest with the corresponding recovery in revenue, partially offset by the impact of pushdown accounting to fair value long-term debt of $10 million.
See Note (E) to the Condensed Consolidated Financial Statements herein for additional information relating to debt issuances and repayments.
Earnings from Equity Method Investments
Third Quarter 2016 vs. Third Quarter 2015
 
Combined Year-to-Date 2016 vs. Year-to-Date 2015
(change in millions)
 
(% change)
 
(change in millions)
 
(% change)
$27
 
N/M
 
$27
 
N/M
N/M - not meaningful
In the third quarter 2016, earnings from equity method investments were $29 million compared to $2 million for the corresponding period in 2015. For combined year-to-date 2016, earnings from equity method investments were $31 million compared to $4 million for the corresponding period in 2015. The increases were due to $27 million of earnings from the investment in SNG in September 2016, which included the recognition of a contract termination fee.
See Notes (I) and (K) to the Condensed Consolidated Financial Statements herein for additional information relating to this investment.
Income Taxes
Third Quarter 2016 vs. Third Quarter 2015
 
Combined Year-to-Date 2016 vs. Year-to-Date 2015
(change in millions)
 
(% change)
 
(change in millions)
 
(% change)
$—
 
—%
 
$(56)
 
(37.3)%
In both the third quarters 2016 and 2015, income taxes were $7 million. For combined year-to-date 2016, income taxes were $94 million compared to $150 million in the corresponding period in 2015. The effective tax rates in 2016 were impacted by the nondeductibility of certain Merger-related expenses and other charges, which were re-assessed in the second and third quarters 2016 and resulted in additional income tax expense of $11 million for combined year-to-date 2016. Also contributing to the decrease were lower pre-tax earnings.
See Note (G) to the Condensed Consolidated Financial Statements herein for additional information regarding income taxes.


MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Segment Information
Operating margin, operating expenses, and EBIT information for each of Southern Company Gas' segments is contained in the tables below. A reconciliation of operating revenue and operating margin to operating income and EBIT to income before income taxes and net income is contained in "Combined Operating Results" herein. See Note (J) to the Condensed Consolidated Financial Statements herein for additional segment information.
 
 
Successor
 
 
Predecessor
 
 
Third Quarter 2016
 
 
Third Quarter 2015
 
 
Operating margin (*)
 
Operating expenses (*)
 
EBIT
 
 
Operating margin (*)
 
Operating expenses (*)
 
EBIT
 
 
(in millions)
 
 
(in millions)
Gas distribution operations
 
$
353

 
$
284

 
$
75

 
 
$
341

 
$
256

 
$
86

Gas marketing services
 
45

 
51

 
(6
)
 
 
48

 
37

 
11

Wholesale gas services
 
(8
)
 
10

 
(17
)
 
 
33

 
15

 
18

Gas midstream operations
 
9

 
13

 
25

 
 
9

 
25

 
(16
)
All other
 
2

 
31

 
(27
)
 
 

 
39

 
(37
)
Intercompany eliminations
 
(1
)
 
(1
)
 

 
 
(1
)
 
(1
)
 

Consolidated
 
$
400

 
$
388

 
$
50

 
 
$
430

 
$
371

 
$
62

(*)
Operating margin and operating expenses are adjusted for revenue tax expenses, which are passed through directly to customers.
 
 
Combined
 
 
Predecessor
 
 
Year-to-Date 2016
 
 
Year-to-Date 2015
 
 
Operating margin (*)
 
Operating expenses (*)
 
EBIT
 
 
Operating margin (*)
 
Operating expenses (*)
 
EBIT
 
 
(in millions)
 
 
(in millions)
Gas distribution operations
 
$
1,264

 
$
844

 
$
428

 
 
$
1,213

 
$
798

 
$
420

Gas marketing services
 
235

 
132

 
103

 
 
237

 
122

 
115

Wholesale gas services
 
(44
)
 
43

 
(85
)
 
 
118

 
52

 
66

Gas midstream operations
 
24

 
37

 
19

 
 
27

 
48

 
(20
)
All other
 
6

 
96

 
(87
)
 
 
4

 
49

 
(41
)
Intercompany eliminations
 
(5
)
 
(5
)
 

 
 
(4
)
 
(4
)
 

Consolidated
 
$
1,480

 
$
1,147

 
$
378

 
 
$
1,595

 
$
1,065

 
$
540

(*)
Operating margin and operating expenses are adjusted for revenue tax expenses, which are passed through directly to customers.
Gas Distribution Operations
The gas distribution operations segment is the largest component of Southern Company Gas' business and is subject to regulation and oversight by agencies in each of the states it serves. These agencies approve natural gas rates designed to provide Southern Company Gas the opportunity to generate revenues to recover the cost of natural gas delivered to its customers and its fixed and variable costs, such as depreciation, interest, maintenance and overhead costs, and to earn a reasonable return on its investments.
With the exception of Atlanta Gas Light, Southern Company Gas' second largest utility that operates in a deregulated natural gas market and has a straight-fixed-variable rate design that minimizes the variability of its revenues based on consumption, the earnings of Southern Company Gas' regulated utilities can be affected by customer consumption patterns that are a function of weather conditions, price levels for natural gas, and general economic conditions that may impact customers’ ability to pay for natural gas consumed. Southern Company Gas has various weather mechanisms, such as weather normalization mechanisms and weather derivative instruments, that limit its exposure to weather changes within typical ranges in its respective service areas. Gas distribution operations' EBIT decreased by $11 million for the third quarter 2016 and increased by $8 million for combined year-to-date 2016 compared to the corresponding periods in 2015, as shown in the following table.


MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 
 
Quarter
 
Combined
Year-to-Date
 
 
(in millions)
EBIT – September 30, 2015
 
$
86

 
$
420

Operating margin
 
 

 
 

Increase from pipeline infrastructure programs, primarily at Atlanta Gas Light and Nicor Gas
 
19

 
55

Decrease in rider program recoveries at Nicor Gas, offset by operating expenses below
 
(7
)
 

Increase mainly driven by non-weather-related customer usage and growth
 

 
11

Decrease in weather-related customer usage, net of weather hedges
 

 
(15
)
Increase in operating margin
 
12

 
51

Operating expenses
 
 

 
 

Increase due to customer rate credits at Elizabethtown Gas in accordance with Merger approval
 
18

 
18

Increase in other expenses primarily due to pipeline compliance and maintenance costs
 
8

 
16

Increase in depreciation due to additional assets placed in service
 
7

 
20

Increase in variable incentive compensation costs
 
5

 

Decrease in benefit expenses primarily related to lower pension costs
 
(3
)
 
(8
)
Decrease in rider program recoveries at Nicor Gas, offset by operating margin above
 
(7
)
 

Increase in operating expenses
 
28

 
46

Increase in other income primarily due to tax gross-up of contributions received from customers
 
5

 
3

EBIT – September 30, 2016
 
$
75

 
$
428

Gas Marketing Services
The gas marketing services segment consists of several businesses that provide energy-related products and services to natural gas markets. Gas marketing services is weather sensitive and uses a variety of hedging strategies, such as weather derivative instruments and other risk management tools, to partially mitigate potential weather impacts. For the third quarter and combined year-to-date 2016, gas marketing services' EBIT decreased by $17 million and $12 million, respectively, compared to the corresponding periods in 2015, as shown in the following table.
 
 
Quarter
 
Combined
Year-to-Date
 
 
(in millions)
EBIT – September 30, 2015
 
$
11

 
$
115

Operating margin
 
 

 
 

Increase in value of unrealized hedge movement as a result of changes in NYMEX natural gas prices, net of recoveries
 
2

 
1

Increase in warranty margins, including the impact of warranty service contracts acquired in the second half of 2015
 
2

 
6

Increase (decrease) in gas marketing margins
 
(3
)
 
3

Decrease in warranty margins due to purchase accounting adjustments to eliminate deferred revenues
 
(4
)
 
(4
)
LOCOM adjustments, net of recoveries
 

 
(1
)
Decrease in weather-related customer usage, net of weather hedging
 

 
(4
)
Decrease in interruptible commercial opportunities
 

 
(3
)
Decrease in operating margin
 
(3
)
 
(2
)
Operating expenses
 
 

 
 

Increase in depreciation and amortization primarily due to intangible asset amortization from purchase accounting adjustments
 
11

 
10

Increase in other expenses, primarily marketing, payroll and bad debt expense
 
3

 

Increase in operating expenses
 
14