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EX-32.2 - EXHIBIT 32.2 - SOUTH JERSEY GAS Cosjg-93016ex322.htm
EX-32.1 - EXHIBIT 32.1 - SOUTH JERSEY GAS Cosjg-93016ex321.htm
EX-31.2 - EXHIBIT 31.2 - SOUTH JERSEY GAS Cosjg-93016ex312.htm
EX-31.1 - EXHIBIT 31.1 - SOUTH JERSEY GAS Cosjg-93016ex311.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

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

OR

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

Commission File Number 000-22211

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

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

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

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


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

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

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



TABLE OF CONTENTS

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

2




SOUTH JERSEY GAS COMPANY

CONDENSED STATEMENTS OF INCOME (UNAUDITED)
(In Thousands)

 
 
Three Months Ended
 
September 30,
 
2016
 
2015
Operating Revenues
$
62,025

 
$
58,634

 
 
 
 
Operating Expenses:
 

 
 

Cost of Sales (Excluding depreciation)
26,395

 
22,934

Operations
21,360

 
22,786

Maintenance
4,150

 
4,188

Depreciation
11,735

 
10,421

Energy and Other Taxes
838

 
806

 
 
 
 
Total Operating Expenses
64,478

 
61,135

 
 
 
 
Operating Loss
(2,453
)
 
(2,501
)
 
 
 
 
Other Income and Expense
1,189

 
1,010

 
 
 
 
Interest Charges
(4,058
)
 
(4,809
)
 
 
 
 
Loss Before Income Taxes
(5,322
)
 
(6,300
)
 
 
 
 
Income Taxes
2,007

 
2,871

 
 
 
 
Net Loss
$
(3,315
)
 
$
(3,429
)
 
The accompanying notes are an integral part of the unaudited condensed financial statements.





3



 
 
 
 
 
Nine Months Ended
 
September 30,
 
2016
 
2015
Operating Revenues
$
318,553

 
$
402,104

 
 
 
 
Operating Expenses:
 

 
 

Cost of Sales (Excluding depreciation)
115,695

 
194,455

Operations
69,954

 
80,083

Maintenance
12,793

 
12,114

Depreciation
34,435

 
29,723

Energy and Other Taxes
2,425

 
3,080

 
 
 
 
Total Operating Expenses
235,302

 
319,455

 
 
 
 
Operating Income
83,251

 
82,649

 
 
 
 
Other Income and Expense
3,104

 
3,440

 
 
 
 
Interest Charges
(13,397
)
 
(15,112
)
 
 
 
 
Income Before Income Taxes
72,958

 
70,977

 
 
 
 
Income Taxes
(26,812
)
 
(26,593
)
 
 
 
 
Net Income
$
46,146

 
$
44,384


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


4


SOUTH JERSEY GAS COMPANY

CONDENSED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
(In Thousands)
 
 
Three Months Ended
 
September 30,
 
2016
 
2015
Net Loss
$
(3,315
)
 
$
(3,429
)
 
 
 
 
Other Comprehensive Income (Loss) - Net of Tax: *
 

 
 

 
 
 
 
Unrealized Gain (Loss) on Available-for-Sale Securities
38

 
(98
)
Unrealized Gain on Derivatives - Other
7

 
6

 
 
 
 
Other Comprehensive Income (Loss) - Net of Tax *
45

 
(92
)
 
 
 
 
Comprehensive Loss
$
(3,270
)
 
$
(3,521
)
 
 
 
 

 
 
 
 
 
Nine Months Ended
 
September 30,
 
2016
 
2015
Net Income
$
46,146

 
$
44,384

 
 
 
 
Other Comprehensive Income - Net of Tax: *
 

 
 
 
 
 
 
Unrealized Gain (Loss) on Available-for-Sale Securities
45

 
(81
)
Unrealized Gain on Derivatives - Other
21

 
15

 
 
 
 
Other Comprehensive Income (Loss) - Net of Tax *
66

 
(66
)
 
 
 
 
Comprehensive Income
$
46,212

 
$
44,318

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

5


SOUTH JERSEY GAS COMPANY

CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In Thousands)
 
 
Nine Months Ended
 
September 30,
 
2016
 
2015
Net Cash Provided by Operating Activities
$
108,690

 
$
124,750

 
 
 
 
Cash Flows from Investing Activities:
 

 
 

Capital Expenditures
(161,690
)
 
(147,276
)
Note Receivable
9,919

 
(9,919
)
Net Proceeds from Restricted Investments in Margin Accounts
6,737

 
1,603

Net (Purchase of) Return of Restricted Investments in Escrow
(8,300
)
 
101

Investment in Long-Term Receivables
(8,085
)
 
(13,784
)
Proceeds from Long-Term Receivables
7,528

 
6,556

 
 
 
 
Net Cash Used in Investing Activities
(153,891
)
 
(162,719
)
 
 
 
 
Cash Flows from Financing Activities:
 

 
 

Net Repayments of Short-Term Credit Facilities
(53,400
)
 
(12,100
)
Proceeds from Issuance of Long-Term Debt
61,000

 
80,000

Principal Repayments of Long-Term Debt
(27,000
)
 
(10,100
)
Payments for Issuance of Long-Term Debt
(7
)
 
(8
)
Dividends on Common Stock

 
(19,782
)
Additional Investment by Shareholder
65,000

 

 
 
 
 
Net Cash Provided by Financing Activities
45,593

 
38,010

 
 
 
 
Net Increase in Cash and Cash Equivalents
392

 
41

Cash and Cash Equivalents at Beginning of Period
775

 
1,778

 
 
 
 
Cash and Cash Equivalents at End of Period
$
1,167

 
$
1,819

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

6


SOUTH JERSEY GAS COMPANY

CONDENSED BALANCE SHEETS (UNAUDITED)
(In Thousands)
 
 
September 30,
2016
 
December 31,
2015
Assets
 
 
 
Property, Plant and Equipment:
 
 
 
Utility Plant, at original cost
$
2,358,302

 
$
2,211,239

Accumulated Depreciation
(467,359
)
 
(440,473
)
 
 
 
 
Property, Plant and Equipment - Net
1,890,943

 
1,770,766

 
 
 
 
Investments:
 

 
 

Available-for-Sale Securities
9,260

 
8,788

Restricted Investments
8,332

 
6,769

 
 
 
 
Total Investments
17,592

 
15,557

 
 
 
 
Current Assets:
 

 
 

Cash and Cash Equivalents
1,167

 
775

Note Receivable

 
9,916

Accounts Receivable
59,020

 
64,445

Accounts Receivable - Related Parties
1,680

 
1,972

Unbilled Revenues
13,432

 
25,613

Provision for Uncollectibles
(11,055
)
 
(9,778
)
Natural Gas in Storage, average cost
13,930

 
14,294

Materials and Supplies, average cost
931

 
937

Prepaid Taxes
24,385

 
21,483

Derivatives - Energy Related Assets
2,281

 
1,077

Other Prepayments and Current Assets
15,782

 
13,405

 
 
 
 
Total Current Assets
121,553

 
144,139

 
 
 
 
Regulatory and Other Noncurrent Assets:
 

 
 

Regulatory Assets
397,071

 
323,434

Long-Term Receivables
25,370

 
24,950

Derivatives - Energy Related Assets
281

 
64

Other
3,502

 
2,666

 
 
 
 
Total Regulatory and Other Noncurrent Assets
426,224

 
351,114

 
 
 
 
Total Assets
$
2,456,312

 
$
2,281,576

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

7


SOUTH JERSEY GAS COMPANY

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

 
$
5,848

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

 
250,827

Accumulated Other Comprehensive Loss
(12,796
)
 
(12,862
)
Retained Earnings
510,260

 
464,114

 
 
 
 
Total Common Equity
819,139

 
707,927

 
 
 
 
Long-Term Debt (see Note 1)
423,983

 
577,454

 
 
 
 
Total Capitalization
1,243,122

 
1,285,381

 
 
 
 
Current Liabilities:
 

 
 

Notes Payable
81,000

 
134,400

Current Portion of Long-Term Debt
215,909

 
27,909

Accounts Payable - Commodity
10,933

 
8,936

Accounts Payable - Other
26,121

 
40,579

Accounts Payable - Related Parties
5,668

 
7,552

Derivatives - Energy Related Liabilities
3,276

 
5,489

Derivatives - Other Current
535

 

Customer Deposits and Credit Balances
41,497

 
19,531

Environmental Remediation Costs
58,174

 
48,323

Taxes Accrued
1,678

 
1,930

Pension Benefits
2,227

 
2,227

Interest Accrued
4,641

 
5,989

Other Current Liabilities
3,564

 
5,686

 
 
 
 
Total Current Liabilities
455,223

 
308,551

 
 
 
 
Regulatory and Other Noncurrent Liabilities:
 

 
 

Regulatory Liabilities
51,050

 
42,841

Deferred Income Taxes - Net
460,464

 
432,674

Environmental Remediation Costs
102,413

 
74,871

Asset Retirement Obligations
58,377

 
57,219

Pension and Other Postretirement Benefits
70,564

 
65,491

Derivatives - Energy Related Liabilities
73

 
351

Derivatives - Other Noncurrent
9,811

 
7,631

Other
5,215

 
6,566

 
 
 
 
Total Regulatory and Other Noncurrent Liabilities
757,967

 
687,644

 
 
 
 
Commitments and Contingencies (Note 9)


 


 
 
 
 
Total Capitalization and Liabilities
$
2,456,312

 
$
2,281,576

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

8


NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS

1.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

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

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

REVENUE - BASED TAXES - SJG collects certain revenue-based energy taxes from its customers. Such taxes include the New Jersey State Sales Tax and Public Utilities Assessment (PUA). State sales tax is recorded as a liability when billed to customers and is not included in revenue or operating expenses. The PUA is included in both revenues and energy and other taxes, and totaled $0.2 million for both the three months ended September 30, 2016 and 2015, and $0.7 million and $1.0 million for the nine months ended September 30, 2016 and 2015, respectively.

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

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

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

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

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

9



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

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

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

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

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

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

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

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. This standard is intended to provide guidance concerning the classification of certain cash receipts and cash payments in the statement of cash flows and to eliminate the diversity in practice related to such classifications. This standard is effective for annual periods, including interim periods within those annual periods, beginning after December 15, 2017, with early adoption permitted. Management is currently determining the impact that adoption of this guidance will have on the Company's financial statement results.



10



2.
STOCK-BASED COMPENSATION PLANS:

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

Beginning in 2015, SJI granted time-based shares of restricted stock, one-third of which vest annually over a three-year period and are limited to a 100% payout. Vesting of time-based grants is contingent upon SJI achieving a return on equity (ROE) of at least 7% during the initial year of the grant and meeting the service requirement. Provided that the 7% ROE requirement is met in the initial year, payment is solely contingent upon the service requirement being met in years two and three of the grant. During the nine months ended September 30, 2016 and 2015, SJG officers and other key employees were granted 9,965 and 7,878 shares of time-based restricted stock, respectively.

Grants containing market-based performance targets use SJI's total shareholder return (TSR) relative to a peer group to measure performance. As TSR-based grants are contingent upon market and service conditions, SJI is required to measure and recognize stock-based compensation expense based on the fair value at the date of grant on a straight-line basis over the requisite three-year period of each award. In addition, SJI identifies specific forfeitures of share-based awards, and compensation expense is adjusted accordingly over the requisite service period. Compensation expense is not adjusted based on the actual achievement of performance goals. The fair value of TSR-based restricted stock awards on the date of grant is estimated using a Monte Carlo simulation model.

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

We are allocated a portion of SJI's compensation cost during the vesting period. We accrue a liability and record compensation cost over the requisite three-year service period based on the grant date fair value as described above for each type of grant. Upon vesting, we make a cash payment to SJI equal to the amounts accrued as compensation cost during the vesting period. Since the inception of the plans, our expense recognition policy has been consistent with the expense recognition policy at SJI.

The following table summarizes the SJI nonvested restricted stock awards pertaining to SJG outstanding at September 30, 2016, and the assumptions used to estimate the fair value of the awards:

Grants
 
Shares
Outstanding
 
Fair Value
Per Share
 
Expected
Volatility
 
Risk-Free
Interest Rate
2014 - TSR
 
9,692

 
$
21.31

 
20.0
%
 
0.80
%
2014 - EGR
 
9,692

 
$
27.22

 
n/a

 
n/a

2015 - TSR
 
6,884

 
$
26.31

 
16.0
%
 
1.10
%
2015 - EGR, ROE, Time
 
15,211

 
$
29.47

 
n/a

 
n/a

2016 - TSR
 
11,472

 
$
22.53

 
18.1
%
 
1.31
%
2016 - CEGR, Time
 
21,305

 
$
23.52

 
n/a

 
n/a

 
Expected volatility is based on the actual volatility of SJI’s share price over the preceding three-year period as of the valuation date. The risk-free interest rate is based on the zero-coupon U.S. Treasury Bond, with a term equal to the three-year term of the restricted shares. As notional dividend equivalents are credited to the holders during the three-year service period, no reduction to the fair value of the award is required.

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

11



As of September 30, 2016, there was $0.9 million of total unrecognized compensation cost related to nonvested share-based compensation awards granted under the plans. That cost is expected to be recognized over a weighted average period of 1.9 years.

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

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

 
$
26.67

 
 
 
 
Granted
33,218

 
$
23.17

Canceled / Forfeited
(2,827
)
 
$
25.89

   Vested
(2,610
)
 
29.47

 
 
 
 
Nonvested Shares Outstanding, September 30, 2016
74,256

 
$
25.04


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




3.
RATES AND REGULATORY ACTIONS:

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

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

In February 2016, SJG filed a petition with the BPU for approval to continue its Accelerated Infrastructure Replacement Program (AIRP), which will expire at the end of 2016. In its petition, SJG has requested approval to continue its AIRP for an additional seven years, with program investments totaling approximately $500.0 million, to retire and replace bare steel and cast iron mains, bare steel services, and other aging infrastructure. The petition proposes to recover the costs of, and a return on, future AIRP investments through annual base rate adjustments. The petition also includes a request to reflect in base rates approximately $76.0 million of AIRP investments that will have been made since the conclusion of SJG’s last base rate case in October 2014 through the end of 2016. This petition was approved in October 2016 (see Note 15).

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


12


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

In June 2016, SJG filed its annual EET rate adjustment petition, requesting a $0.8 million decrease in revenues to continue recovering the costs of, and the allowed return on, prior investments associated with EEP's. The revenue adjustment was subsequently updated in September 2016 to reflect a revenue decrease of $1.6 million. The EET rate recovers the forecasted revenue requirements for the upcoming EET year of October 2016 to September 2017. The requested revenue decrease is the result of the investments associated with SJG's original EEPs, approved by the BPU in 2009, and its EEP extension, approved by the BPU in 2013, which ended in July 2013 and August 2015, respectively. The revenue requirements associated with these prior investments decreases over time as they are amortized. This petition was approved in October 2016.

In September 2016, the BPU approved an increase in annual revenues from base rates of $3.9 million, including taxes, to reflect the roll-in of $33.7 million of investments made from July 1, 2015 through June 30, 2016 under SJG's’s Storm Hardening and Reliability Program (SHARP), with rates effective as of October 1, 2016.

Also in September 2016, the BPU approved a $0.6 million net decrease in annual revenues to be implemented on October 1, 2016, comprised of a $47.1 million decrease in BGSS revenues and a $46.5 million increase in Conservation Incentive Program (CIP) revenues, both including taxes. The level of BGSS revenues requested in annual BGSS filings is based on forecasted gas costs and customer usage information for the upcoming BGSS/CIP year, which runs from October 1, 2016 to September 30, 2017. SJG’s request for a decrease of BGSS revenues was caused primarily by decreases in forecasted gas commodity costs for the upcoming BGSS/CIP year. The level of CIP revenues requested in annual CIP filings is based on historical customer usage information, comparing prior CIP year customer usage to normal customer usage. SJG’s request for an increase in CIP revenues was primarily due to lower than normal customer usage caused by weather that was 16.4% warmer than normal during the 2015- 2016 winter.

Additionally, in September 2016, the BPU approved the statewide Universal Service Fund (USF) budget of $56.0 million for all the State’s gas utilities. SJG’s portion of the total budget is approximately $5.6 million. Effective October 1, 2016, the BPU approved a $1.1 million increase in SJG’s USF recoveries.

The BGSS, CIP and USF approvals discussed above do not impact SJG's earnings. They represent changes in the cash requirements of SJG corresponding to cost changes and/or the return of previously under-recovered costs associated with each respective mechanism.

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


13



4.
REGULATORY ASSETS AND LIABILITIES:

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

Regulatory Assets consisted of the following items (in thousands):
 
September 30, 2016
 
December 31, 2015
Environmental Remediation Costs:
 
 
 
Expended - Net
$
57,100

 
$
42,032

Liability for Future Expenditures
160,587

 
123,194

Deferred Asset Retirement Obligation Costs
42,768

 
42,430

Deferred Pension and Other Postretirement Benefit Costs
79,779

 
79,779

Deferred Gas Costs - Net

 
2,701

Conservation Incentive Program Receivable
23,485

 
2,624

Deferred Interest Rate Contracts (Note 11)
10,346

 
7,631

Energy Efficiency Tracker

 
496

Pipeline Supplier Service Charges
2,527

 
3,776

Pipeline Integrity Cost
4,595

 
4,596

AFUDC - Equity Related Deferrals
12,357

 
11,423

Other Regulatory Assets
3,527

 
2,752

 
 
 
 
Total Regulatory Assets
$
397,071

 
$
323,434


ENVIRONMENTAL REMEDIATION COSTS - We have two regulatory assets associated with environmental costs related to the cleanup of 12 sites where we or our predecessors previously operated gas manufacturing plants. The first asset, "Environmental Remediation Cost: Expended - Net," represents what was actually spent to clean up the sites, less recoveries through the Remediation Adjustment Clause (RAC) and insurance carriers. These costs meet the deferral requirements of GAAP, as the BPU allows us to recover such expenditures through the RAC. The other asset, "Environmental Remediation Cost: Liability for Future Expenditures," relates to estimated future expenditures required to complete the remediation of these sites. We recorded this estimated amount as a regulatory asset with the corresponding current and noncurrent liabilities on the balance sheets under the captions "Current Liabilities" and "Regulatory and Other Noncurrent Liabilities." The BPU allows us to recover the deferred costs over seven-year periods after they are spent. The increase from December 31, 2015 is a result of expenditures made during the first nine months of 2016 and an increase in the expected future expenditures for remediation activities primarily due to an increase in the scope of the remediation at a site related to additional contamination being discovered.

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

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



14


Regulatory Liabilities consisted of the following items (in thousands):
 
September 30, 2016
 
December 31, 2015
Excess Plant Removal Costs
$
30,324

 
$
32,644

Deferred Revenues-Net
14,418

 

Societal Benefit Costs
5,907

 
10,197

Energy Efficiency Tracker
401

 

 


 


Total Regulatory Liabilities
$
51,050

 
$
42,841


DEFERED REVENUES - NET - Over/under collections of gas costs are monitored through SJG's BGSS mechanism. Net under collected gas costs are classified as a regulatory asset and net over collected gas costs are classified as a regulatory liability. Derivative contracts used to hedge natural gas purchases are also included in the BGSS, subject to BPU approval. The BGSS changed from a $2.7 million regulatory asset at December 31, 2015 to a $14.4 million regulatory liability at September 30, 2016, primarily due to the gas costs recovered from customers exceeding the actual cost of the commodity.

ENERGY EFFICIENCY TRACKER (EET) - This regulatory liability primarily represents energy efficiency measures installed in customer homes and businesses. The change from a $0.5 million regulatory asset at December 31, 2015 to a $0.4 million regulatory liability at September 30, 2016 is due to recoveries being greater than the cost of, and allowed return on, investments in the EEP's. In February 2016, the BPU approved a $7.9 million revenue decrease to SJG’s EET (see Note 3).



5.
RELATED-PARTY TRANSACTIONS:

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

A summary of related-party transactions, excluding pass-through items, included in Operating Revenues were as follows (in thousands):
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2016
 
2015
 
2016
 
2015
Operating Revenues/Affiliates:
 
 
 
 
 
 
 
SJRG
$
977

 
$
1,100

 
$
5,399

 
$
2,631

Marina
86

 
116

 
292

 
483

Total Operating Revenue/Affiliates
$
1,063

 
$
1,216

 
$
5,691

 
$
3,114


Related-party transactions, excluding pass-through items, included in Operating Expenses were as follows (in thousands):
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2016
 
2015
 
2016
 
2015
Costs of Sales/Affiliates (Excluding depreciation)
 
 
 
 
 
 
 
SJRG
$
490

 
$
574

 
$
9,993

 
$
21,105

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

 
$

 
$

 
$
65


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


15


Operations Expense/Affiliates:
 
 
 
 
 
 
 
SJI
$
4,632

 
$
3,248

 
$
14,502

 
$
10,529

Millennium
703

 
695

 
2,098

 
2,048

Other
(48
)
 
(95
)
 
(154
)
 
(312
)
Total Operations Expense/Affiliates
$
5,287

 
$
3,848

 
$
16,446

 
$
12,265




6.
FINANCIAL INSTRUMENTS:

RESTRICTED INVESTMENTS - In accordance with the terms of our tax-exempt first mortgage bonds, unused proceeds are required to be escrowed pending approved construction expenditures. As of both September 30, 2016 and December 31, 2015, the escrowed proceeds, including interest earned, totaled $32,225. SJG maintains a margin account with a counterparty in conjunction with SJG's risk management activities as detailed in Note 11. The funds provided by SJG will increase or decrease as the number and value of outstanding energy-related contracts held with this counterparty change. As of September 30, 2016, the balance owed to this counterparty totaled $0.3 million and as of December 31, 2015, the balance held with this counterparty totaled $6.7 million. In September 2016, SJG placed $8.3 million in an escrow account to construct SJG's building in Atlantic City, New Jersey. The money is restricted until the final contracts are approved, at which time the money will be released for use in constructing SJG's building. The carrying amounts of the Restricted Investments approximate their fair value at September 30, 2016 and December 31, 2015, which would be included in Level 1 of the fair value hierarchy. (See Note 10 - Fair Value of Financial Assets and Financial Liabilities.)

NOTE RECEIVABLE - In June 2015, SJG advanced $10.0 million to a not-for-profit organization formed to spur economic development in Atlantic City, New Jersey. The Note included interest at 1% for an initial term of six months, with the borrower’s option to extend the term for two additional terms of three months each. In December 2015 and February 2016, the borrower exercised each option, respectively. In July 2016, the note was repaid in full, including interest.
LONG-TERM RECEIVABLES – SJG provides financing to customers for the purpose of attracting conversions to natural gas heating systems from competing fuel sources. The terms of these loans call for customers to make monthly payments over a period of up to five to ten years with no interest. The carrying amounts of such loans were $10.2 million and $12.9 million as of September 30, 2016 and December 31, 2015, respectively. The current portion of these receivables is reflected in Accounts Receivable and the non-current portion is reflected in Long-Term Receivables on the condensed balance sheets. The carrying amounts noted above are net of unamortized discounts resulting from imputed interest in the amount of $1.0 million and $1.3 million as of September 30, 2016 and December 31, 2015, respectively. The annualized amortization to interest is not material to SJG’s financial statements. The carrying amounts of these receivables approximate their fair value at September 30, 2016 and December 31, 2015, which would be included in Level 2 of the fair value hierarchy (See Note 10 - Fair Value of Financial Assets and Financial Liabilities).
 
FINANCIAL INSTRUMENTS NOT CARRIED AT FAIR VALUE - The fair value of a financial instrument is the market price to sell an asset or transfer a liability at the measurement date. The carrying amounts of SJG's financial instruments approximate their fair values at September 30, 2016 and December 31, 2015, except as noted below.
For Long-Term Debt, in estimating the fair value, we use the present value of remaining cash flows at the balance sheet date. We based the estimates on interest rates available to SJG at the end of each period for debt with similar terms and maturities (Level 2 in the fair value hierarchy. See Note 10 - Fair Value of Financial Assets and Financial Liabilities). The estimated fair values of SJG's long-term debt, including current maturities, as of September 30, 2016 and December 31, 2015, were $699.7 million and $657.4 million, respectively. The carrying amount of SJG's long-term debt, including current maturities, as of September 30, 2016 and December 31, 2015, was $639.9 million and $605.4 million, respectively. The carrying amounts as of September 30, 2016 and December 31, 2015 are net of unamortized debt issuance costs of $6.1 million and $6.6 million, respectively (see Note 1).



16



7.
LINES OF CREDIT:

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

 
$
81,800

(A)
$
118,200

 
May 2018
 
Uncommitted Bank Lines
10,000

 

 
10,000

 
August 2017
 
 
 
 
 
 
 
 
 
 
Total
$
210,000

 
$
81,800

(A)
$
128,200

 
 
 

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


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

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

Average borrowings outstanding under these credit facilities during the nine months ended September 30, 2016 and 2015 were $64.5 million and $117.9 million, respectively. The maximum amount outstanding under these credit facilities during the nine months ended September 30, 2016 and 2015 were $141.7 million and $162.3 million, respectively.

Borrowings under these credit facilities are at market rates. The weighted average interest rate on these borrowings, which changes daily, was 0.76% and 0.40% at September 30, 2016 and 2015, respectively.



8.
PENSION AND OTHER POSTRETIREMENT BENEFITS:

For the three and nine months ended  September 30, 2016 and 2015, net periodic benefit cost related to the employee and officer pension and other postretirement benefit plans consisted of the following components (in thousands):
 
Pension Benefits
 
Pension Benefits
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2016
 
2015
 
2016
 
2015
Service Cost
$
892

 
$
996

 
$
2,675

 
$
2,988

Interest Cost
2,233

 
2,083

 
6,699

 
6,251

Expected Return on Plan Assets
(2,488
)
 
(2,759
)
 
(7,463
)
 
(8,278
)
Amortizations:
 
 
 
 
 
 
 
Prior Service Cost
39

 
40

 
117

 
119

Actuarial Loss
1,730

 
1,979

 
5,190

 
5,938

Net Periodic Benefit Cost
2,406

 
2,339

 
7,218

 
7,018

Capitalized Benefit Cost
(1,251
)
 
(1,216
)
 
(3,651
)
 
(3,649
)
Deferred Benefit Cost
(161
)
 
(341
)
 
(483
)
 
(666
)
Total Net Periodic Benefit Expense
$
994

 
$
782

 
$
3,084

 
$
2,703


17


 
Other Postretirement Benefits
 
Other Postretirement Benefits
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
 
2016
 
2015
 
2016
 
2015
 
Service Cost
$
106

 
$
186

 
$
318

 
$
558

 
Interest Cost
325

 
495

 
977

 
1,486

 
Expected Return on Plan Assets
(386
)
 
(499
)
 
(1,159
)
 
(1,496
)
 
Amortizations:

 


 

 

 
Prior Service Cost
(43
)
 
102

 
(129
)
 
304

 
Actuarial Loss
138

 
224

 
414

 
671

 
Net Periodic Benefit Cost
140

 
508

 
421

 
1,523

 
Capitalized Benefit Cost
(73
)
 
(264
)
 
(219
)
 
(792
)
 
Deferred Benefit Cost

 
(89
)
 

 
(168
)
 
Total Net Periodic Benefit Expense
$
67

 
$
155

 
202

 
563

 

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

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

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


9.    COMMITMENTS AND CONTINGENCIES:

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

ENVIRONMENTAL REMEDIATION COSTS - SJG incurred and recorded costs for environmental cleanup of 12 sites where SJG or its predecessors operated gas manufacturing plants. SJG stopped manufacturing gas in the 1950s. Other than the changes discussed in Note 4 to the condensed financial statements, there have been no significant changes to the status of SJG’s environmental remediation efforts since December 31, 2015, as described in Note 12 to the Financial Statements in Item 8 of SJG’s Annual Report on Form 10-K for the year ended December 31, 2015.

GAS SUPPLY RELATED CONTRACTS - In the normal course of conducting business, we have entered into long-term contracts for natural gas supplies, firm transportation and gas storage service. The earliest date at which any of the primary terms of these contracts expire is October 2017. The transportation and storage agreements entered into between us and each of our interstate pipeline service providers were done in accordance with their respective FERC-approved tariffs. Our cumulative obligation for gas supply-related demand charges and reservation fees paid for these services averages approximately $5.8 million per month and is recovered on a current basis through the BGSS.


18


PENDING LITIGATION - SJG is subject to claims arising in the ordinary course of business and other legal proceedings. SJG accrues liabilities related to these claims when SJG can reasonably estimate the amount or range of amounts of probable settlement costs or other charges for these claims. SJG has accrued approximately $0.7 million and $0.8 million related to all claims in the aggregate as of September 30, 2016 and December 31, 2015, respectively. 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 $14.3 million through September 30, 2016 under the same contract, which would be recoverable in rates. Liabilities related to these claims are accrued when the amount or range of amounts of probable settlement costs or other charges for these claims can be reasonably estimated.

COLLECTIVE BARGAINING AGREEMENTS - Unionized personnel represent approximately 61% of our workforce at September 30, 2016. The Company has collective bargaining agreements with two unions who represent these employees: the International Brotherhood of Electrical Workers (IBEW) operates under a collective bargaining agreement that runs through February 2017; and the International Association of Machinists and Aerospace Workers (IAM) operates under a collective bargaining agreement that expires in August 2017.


 
10.
FAIR VALUE OF FINANCIAL ASSETS AND FINANCIAL LIABILITIES:

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

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

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

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

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

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

As of September 30, 2016
 
 
 
 
 
 
 
 
Total
 
Level 1
 
Level 2
 
Level 3
Assets
 
 
 
 
 
 
 
Available-for-Sale Securities (A)
$
9,260

 
$
1,825

 
$
7,435

 
$

Derivatives – Energy Related Assets (B)
2,562

 
1,771

 
7

 
784

 
$
11,822

 
$
3,596

 
$
7,442

 
$
784

 
 
 
 
 
 
 
 
Liabilities
 

 
 

 
 

 
 

 
 
 
 
 
 
 
 
Derivatives – Energy Related Liabilities (B)
$
3,349

 
$
582

 
$
2,489

 
$
278

Derivatives – Other (C)
10,346

 

 
10,346

 

 
$
13,695

 
$
582

 
$
12,835

 
$
278



19


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

 
$
1,722

 
$
7,066

 
$

Derivatives - Energy Related Assets (B)
1,141

 
398

 
144

 
599

 
$
9,929

 
$
2,120

 
$
7,210

 
$
599

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

 
$
5,424

 
$

 
$
416

Derivatives - Other (C)
7,631

 

 
7,631

 

 
$
13,471

 
$
5,424

 
$
7,631

 
$
416


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

(B)  Derivatives – Energy Related Assets and Liabilities are traded in both exchange-based and non-exchange-based markets. Exchange-based contracts are valued using unadjusted quoted market sources in active markets and are categorized in Level 1 in the fair value hierarchy. Certain non-exchange-based contracts are valued using indicative price quotations available through brokers or over-the-counter, on-line exchanges and are categorized in Level 2. These price quotations reflect the average of the bid-ask mid-point prices and are obtained from sources that management believes provide the most liquid market. For non-exchange-based derivatives that trade in less liquid markets with limited pricing information, model inputs generally would include both observable and unobservable inputs. In instances where observable data is unavailable, management considers the assumptions that market participants would use in valuing the asset or liability. This includes assumptions about market risks such as liquidity, volatility and contract duration. Such instruments are categorized in Level 3 as the model inputs generally are not observable.

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

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

(C)  Derivatives – Other, include interest rate swaps that are valued using quoted prices on commonly quoted intervals, which are interpolated for periods different than the quoted intervals, as inputs to a market valuation model. Market inputs can generally be verified and model selection does not involve significant management judgment.


20


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

Type
Fair Value at September 30, 2016
Valuation Technique
Significant Unobservable Input
Range
[Weighted Average]


Assets
Liabilities




Forward Contract - Natural Gas
$784
$278
Discounted Cash Flow
Forward price (per dt)

$0.9 - $6.80
[$4.24]
(A)
 
 
 
 
 
 
 

Type
Fair Value at December 31, 2015
Valuation Technique
Significant Unobservable Input
Range
[Weighted Average]


Assets
Liabilities




Forward Contract - Natural Gas
$599
$416
Discounted Cash Flow
Forward price (per dt)

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

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

The changes in fair value measurements of Derivatives - Energy Related Assets and Liabilities for the three and nine months ended September 30, 2016, using significant unobservable inputs (Level 3), are as follows (in thousands):
 
Three Months
Ended
September 30, 2016
 
Nine Months Ended
September 30,
2016
Balance at beginning of period
$
(224
)
 
$
183

Other Changes in Fair Value from Continuing and New Contracts, Net
730

 
506

Settlements

 
(183
)
 
 
 
 
Balance at end of period
506

 
506



The changes in fair value measurements of Derivatives - Energy Related Assets and Liabilities for the three and nine months ended September 30, 2015, using significant unobservable inputs (Level 3), are as follows (in thousands):
 
Three Months
Ended
September 30, 2015
 
Nine Months Ended
September 30, 2015
Balance at beginning of period
$
(584
)
 
$

Other Changes in Fair Value from Continuing and New Contracts, Net
1,035

 
451

 
 
 
 
Balance at end of period
451

 
451




21



11. DERIVATIVE INSTRUMENTS:

SJG is involved in buying, selling, transporting and storing natural gas and is subject to market risk on expected future purchases and sales due to commodity price fluctuations. The Company, through a counterparty, uses a variety of derivative instruments to limit this exposure to market risk in accordance with strict corporate guidelines. These derivative instruments include forward contracts, futures contracts, swap agreements and options contracts. As of September 30, 2016, SJG had outstanding derivative contracts intended to limit the exposure to market risk on 8.7 million decatherms (MMdts) of expected future purchases of natural gas and 0.6 MMdts of expected future sales of natural gas. In addition to these derivative contracts, SJG had basis and index related purchase contracts of 4.6 MMdts and sales contracts of 9.0 MMdts for net contracted volumes of 4.4 MMdts. These contracts, which do not qualify for the normal purchase and sale exemption and have not been designated as hedging instruments under GAAP, are measured at fair value and recorded in Derivatives — Energy Related Assets or Derivatives — Energy Related Liabilities on the condensed balance sheets. The costs or benefits of these short-term contracts are recoverable through SJG’s BGSS clause, subject to BPU approval. As a result, the net unrealized pre-tax gains and losses for these energy-related commodity contracts are included with realized gains and losses in Regulatory Assets or Regulatory Liabilities on the condensed balance sheets. As of September 30, 2016 and December 31, 2015, SJG had $0.8 million and $4.7 million of unrealized gains, respectively, included in its BGSS related to open financial contracts.

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

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

Derivatives not designated as hedging instruments under GAAP
 
September 30, 2016
 
December 31, 2015
 
 
Assets
 
Liabilities
 
Assets
 
Liabilities
Energy related commodity contracts:
 
 
 
 
 
 
 
 
Derivatives – Energy Related – Current
 
$
2,281

 
$
3,276

 
$
1,077

 
$
5,489

Derivatives – Energy Related – Non-Current
 
281

 
73

 
64

 
351

Interest rate contracts:
 
 
 
 
 
 
 
 
Derivatives – Other Current
 

 
535

 

 

Derivatives – Other Noncurrent
 

 
9,811

 

 
7,631

Total derivatives not designated as hedging instruments under GAAP
 
2,562

 
13,695

 
1,141

 
13,471

Total Derivatives
 
$
2,562

 
$
13,695

 
$
1,141

 
$
13,471

 

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


22


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

As of September 30, 2016:
 
 
 
 
 
 
 
 
 
 
 
 
Description
 
Gross amounts of recognized assets/liabilities
 
Gross amount offset in the balance sheet
 
Net amounts of assets/liabilities in balance sheet
 
Gross amounts not offset in the balance sheet
 
Net amount
 
 
 
 
Financial Instruments
 
Cash Collateral Posted
 
Derivatives - Energy Related Assets
 
$
2,562

 
$

 
$
2,562

 
$
(582
)
(A)
$
(339
)
 
$
1,641

Derivatives - Energy Related Liabilities
 
(3,349
)
 

 
(3,349
)
 
582

(B)

 
(2,767
)
Derivatives - Other
 
(10,346
)
 

 
(10,346
)
 

 

 
(10,346
)

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

 
$

 
$
1,141

 
$
(399
)
(A)
$

 
$
742

Derivatives - Energy Related Liabilities
 
(5,840
)
 

 
(5,840
)
 
399

(B)
5,025

 
(416
)
Derivatives - Other
 
(7,631
)
 

 
(7,631
)
 

 

 
(7,631
)

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

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

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

 
$
12

 
$
36

 
$
36

(a) Included in Interest Charges

A net realized gain of $0.9 million and a net realized loss of $1.6 million associated with SJG's energy-related financial commodity contracts for the three months ended September 30, 2016 and 2015, and loss of $3.5 million and $6.4 million for the nine months ended September 30, 2016 and 2015, respectively, are not included in the above table. These contracts are part of SJG’s regulated risk management activities that serve to mitigate BGSS costs passed on to its customers. As these transactions are entered into pursuant to, and recoverable through, regulatory riders, any changes in the value of SJG’s energy-related financial commodity contracts are deferred in Regulatory Assets or Liabilities, as applicable, and there is no impact to earnings.


23



12.
LONG-TERM DEBT:

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

In July, SJG retired $17.0 million of 4.60% Medium Term Notes ("MTN's") at maturity.

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

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


13.    ACCUMULATED OTHER COMPREHENSIVE LOSS:

The changes in Accumulated Other Comprehensive Loss (AOCL) for the three and nine months ended September 30, 2016 are as follows (in thousands):
 
 
 
 
 
 
 
 
 
Postretirement Liability Adjustment
 
Unrealized Gain (Loss) on Derivatives-Other
 
Unrealized Gain (Loss) on Available-for-Sale Securities
 
Total
Balance at July 1, 2016 (a)
$
(12,220
)
 
$
(530
)
 
$
(91
)
 
$
(12,841
)
Other comprehensive loss before reclassifications

 

 
167

 
167

   Amounts reclassified from AOCL (b)

 
7

 
(129
)
 
(122
)
Net current period other comprehensive income

 
7

 
38

 
45

Balance at September 30, 2016 (a)
$
(12,220
)
 
$
(523
)
 
$
(53
)
 
$
(12,796
)
 
 
 
 
 
 
 
 
 
Postretirement Liability Adjustment
 
Unrealized Gain (Loss) on Derivatives-Other
 
Unrealized Gain (Loss) on Available-for-Sale Securities
 
Total
Balance at January 1, 2016 (a)
$
(12,220
)
 
$
(544
)
 
$
(98
)
 
$
(12,862
)
Other comprehensive loss before reclassifications

 

 
304

 
304

   Amounts reclassified from AOCL (b)

 
21

 
(259
)
 
(238
)
Net current period other comprehensive income (loss)

 
21

 
45

 
66

Balance at September 30, 2016 (a)
$
(12,220
)
 
$
(523
)
 
$
(53
)
 
$
(12,796
)

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


24


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

 
$
36

 
Interest Charges
Income Taxes
 
(5
)
 
(15
)
 
Income Taxes (a)
 
 
$
7

 
$
21

 
 
 
 
 
 
 
 
 
Unrealized Gain on Available-for-Sale Securities
 
$
(217
)
 
$
(432
)
 
Other Income & Expense
Income Taxes
 
88

 
173

 
Income Taxes (a)
 
 
$
(129
)
 
$
(259
)
 
 
 
 
 
 
 
 
 
Gains from reclassifications for the period net of tax
 
$
(122
)
 
$
(238
)
 
 

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


14.    OTHER PAID IN CAPITAL:

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



15.    SUBSEQUENT EVENT:

In October 2016, the BPU approved SJG’s request to extend its AIRP for a five-year period commencing October 1, 2016 and ending September 30, 2021, with authorized investments of up to $302.5 million to continue replacing cast iron and unprotected bare steel mains and associated services (AIRP II). Cost recovery of AIRP II investments, including a return on SJG’s investments, will be accomplished through annual base rate adjustments that will occur on October 1st of each year of the program. The BPU also approved an increase in annual revenues from base rates of $11.0 million, including taxes, to reflect the roll-in of the remaining $74.5 million of prior AIRP investments, made from the time of SJG’s last base rate case through the end of the first AIRP program, that were not yet reflected in rates. These rates will be effective as of December 1, 2016.





25



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

OVERVIEW:

Organization - We are an operating public utility company engaged in the purchase, transmission and sale of natural gas for residential, commercial and industrial use. We also sell natural gas and pipeline transportation capacity (off-system sales) on a wholesale basis to various customers on the interstate pipeline system and transport natural gas purchased directly from producers or suppliers to their customers. We served 374,637 customers at September 30, 2016 compared with 369,807 customers at September 30, 2015.

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

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

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

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

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

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


26


Customer Choice Legislation - All residential natural gas customers in New Jersey can choose their natural gas commodity supplier under the terms of the “Electric Discount and Energy Competition Act of 1999.” This bill created the framework and necessary time schedules for the restructuring of the state’s electric and natural gas utilities. The Act established unbundling, under which redesigned utility rate structures allow natural gas and electric consumers to choose their energy supplier. Customers purchasing natural gas from a provider other than the local utility (marketer) are charged for the gas costs by the marketer and charged for the transportation costs by the utility. The number of customers purchasing their natural gas from marketers was 34,039 and 35,722 at September 30, 2016 and 2015, respectively.



RESULTS OF OPERATIONS:

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

 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2016
 
2015
 
2016
 
2015
Utility Throughput – decatherms(dt):
 
 
 
 
 
 
 
Firm Sales -
 
 
 
 
 
 
 
Residential
1,320

 
1,499

 
15,490

 
18,788

Commercial
470

 
593

 
3,557

 
4,944

Industrial
17

 
113

 
225

 
378

Cogeneration & Electric Generation
533

 
781

 
1,230

 
1,277

Firm Transportation -
 
 
 
 
 
 
 
Residential
118

 
141

 
1,394

 
1,933

Commercial
795

 
920

 
5,056

 
5,292

Industrial
2,742

 
2,760

 
8,726

 
8,777

Cogeneration & Electric Generation
2,892

 
1,840

 
5,732

 
4,918

 
 
 
 
 
 
 
 
Total Firm Throughput
8,887

 
8,647

 
41,410

 
46,307

 
 
 
 
 
 
 
 
Interruptible Sales

 

 
2

 
20

Interruptible Transportation
237

 
346

 
837

 
998

Off-System Sales
3,428

 
2,031

 
11,200

 
8,652

Capacity Release
19,278

 
16,018

 
53,176

 
45,008

 
 
 
 
 
 
 
 
Total Throughput - Utility
31,830

 
27,042

 
106,625

 
100,985


27


 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2016
 
2015
 
2016
 
2015
Utility Operating Revenues:
 
 
 
 
 
 
 
Firm Sales -
 
 
 
 
 
 
 
Residential
$
28,010

 
$
25,986

 
$
180,508

 
$
238,571

Commercial
7,740

 
7,616

 
38,465

 
54,726

Industrial
309

 
1,032

 
2,118

 
4,154

Cogeneration & Electric Generation
1,923

 
2,619

 
4,104

 
4,907

Firm Transportation -
 
 
 
 
 
 
 
Residential
1,483

 
1,533

 
10,114

 
12,360

Commercial
4,081

 
4,292

 
22,666

 
22,769

Industrial
4,814

 
5,888

 
15,032

 
17,488

Cogeneration & Electric Generation
992

 
947

 
3,364

 
3,943

 
 
 
 
 
 
 
 
Total Firm Revenues
49,352

 
49,913

 
276,371

 
358,918

 
 
 
 
 
 
 
 
Interruptible Sales

 

 
18

 
298

Interruptible Transportation
165

 
312

 
652

 
1,076

Off-System Sales
9,999

 
5,586

 
31,077

 
35,682

Capacity Release
2,230

 
2,460

 
9,611

 
5,118

Other
279

 
363

 
824

 
1,012

Total Utility Operating Revenues
62,025

 
58,634

 
318,553

 
402,104

 
 
 
 
 
 
 
 
Less:
 

 
 

 
 

 
 

Cost of Sales (Excluding depreciation)
26,395

 
22,934

 
115,695

 
194,455

Conservation Recoveries*
731

 
1,648

 
7,864

 
18,772

RAC Recoveries*
2,298

 
2,281

 
6,893

 
6,842

EET Recoveries*
578

 
769

 
2,086

 
2,816

Revenue Taxes
159

 
165

 
697

 
952

Utility Margin**
$
31,864

 
$
30,837

 
$
185,318

 
$
178,267

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Margin: