SJW GROUP - FORM 10-Q - July 27, 2018

Attached files

Large accelerated filer x

Accelerated filer o

Non-accelerated filer o

Smaller reporting company o

(Do not check if a smaller reporting company)

Emerging growth company o

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

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EX-31.1 - CERTIFICATION PURSUANT TO RULE 13A-14(A)/15D-14(A) BY CHAIRMAN, PRESIDENT & CEO - SJW GROUP	sjw-63018xex311.htm
EX-32.2 - CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 BY CFO AND TREASURER - SJW GROUP	sjw-63018xex322.htm
EX-32.1 - CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 BY CHAIRMAN, PRESIDENT & CEO - SJW GROUP	sjw-63018xex321.htm
EX-31.2 - CERTIFICATION PURSUANT TO RULE 13A-14(A)/15D-14(A) BY CFO AND TREASURER - SJW GROUP	sjw-63018xex312.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

___________________________________________

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2018

Commission file number 1-8966

SJW Group

(Exact name of registrant as specified in its charter)



Delaware		77-0066628
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

110 West Taylor Street, San Jose, CA		95110
(Address of principal executive offices)		(Zip Code)

408-279-7800

(Registrant’s telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “non-accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (check one)

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

APPLICABLE ONLY TO CORPORATE ISSUERS:

As of July 23, 2018, there were 20,618,102 shares of the registrant’s Common Stock outstanding.

PART I. FINANCIAL INFORMATION


ITEM 1.	FINANCIAL STATEMENTS

SJW Group and Subsidiaries

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(UNAUDITED)

(in thousands, except share and per share data)



	Three months ended June 30,					Six months ended June 30,
	2018			2017		2018			2017
REVENUE	$	99,086		102,073		$	174,128		171,118
OPERATING EXPENSE:
Production Expenses:
Purchased water	23,712			22,181		39,128			36,105
Power	1,624			1,704		2,892			2,991
Groundwater extraction charges	9,919			10,932		19,451			18,342
Other production expenses	4,626			3,991		8,838			7,851
Total production expenses	39,881			38,808		70,309			65,289
Administrative and general	11,958			11,815		23,526			22,960
Maintenance	4,596			4,487		9,056			8,384
Property taxes and other non-income taxes	3,450			3,111		7,316			6,806
Depreciation and amortization	13,656			12,033		27,239			24,152
Merger related expenses	2,746			—		6,552			—
Total operating expense	76,287			70,254		143,998			127,591
OPERATING INCOME	22,799			31,819		30,130			43,527
OTHER (EXPENSE) INCOME:
Interest on long-term debt and other interest expense	(6,084		)	(5,756	)	(12,136		)	(11,813	)
Pension non-service cost	(595		)	(1,032	)	(1,178		)	(1,907	)
Unrealized gain (loss) on California Water Service Group stock	140			—		(527		)	—
Loss on sale of California Water Service Group stock	—			—		(87		)	—
Gain on sale of real estate investments	—			6,903		—			6,903
Other, net	679			614		1,442			1,077
Income before income taxes	16,939			32,548		17,644			37,787
Provision for income taxes	4,068			11,964		3,488			13,532
NET INCOME BEFORE NONCONTROLLING INTEREST	12,871			20,584		14,156			24,255
Less net income attributable to the noncontrolling interest	—			1,896		—			1,896
SJW GROUP NET INCOME	12,871			18,688		14,156			22,359
Other comprehensive income, net of tax:
Unrealized gain on investment	—			56		—			172
SJW GROUP COMPREHENSIVE INCOME	$	12,871		18,744		$	14,156		22,531
SJW GROUP EARNINGS PER SHARE
Basic	$	0.63		0.91		$	0.69		1.09
Diluted	$	0.62		0.90		$	0.68		1.08
DIVIDENDS PER SHARE	$	0.28		0.22		$	0.56		0.44
WEIGHTED AVERAGE SHARES OUTSTANDING
Basic	20,592,014			20,504,357		20,576,757			20,495,211
Diluted	20,732,127			20,673,775		20,716,665			20,664,556

See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

SJW Group and Subsidiaries

CONDENSED CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

(in thousands, except share and per share data)



	June 30, 2018		December 31, 2017
ASSETS
Utility plant:
Land	$	18,212	17,831
Depreciable plant and equipment	1,755,624		1,714,228
Construction in progress	68,153		45,851
Intangible assets	15,650		14,413
	1,857,639		1,792,323
Less accumulated depreciation and amortization	579,572		553,059
	1,278,067		1,239,264
Real estate investments	56,336		56,213
Less accumulated depreciation and amortization	11,730		11,132
	44,606		45,081
CURRENT ASSETS:
Cash and cash equivalents	8,926		7,799
Accounts receivable:
Customers, net of allowances for uncollectible accounts	21,703		17,305
Income tax	2,252		7,981
Other	1,034		1,118
Accrued unbilled utility revenue	32,950		27,905
Other current assets	6,308		4,750
	73,173		66,858
OTHER ASSETS:
Investment in California Water Service Group	3,207		4,535
Net regulatory assets, less current portion	98,332		99,554
Other	2,736		2,709
	104,275		106,798
	$	1,500,121	1,458,001

See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

SJW Group and Subsidiaries

CONDENSED CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

(in thousands, except share and per share data)



	June 30, 2018		December 31, 2017
CAPITALIZATION AND LIABILITIES
CAPITALIZATION:
Stockholders’ equity:
Common stock, $0.001 par value; authorized 36,000,000 shares; issued and outstanding shares 20,594,486 on June 30, 2018 and 20,520,856 on December 31, 2017	$	21	21
Additional paid-in capital	84,375		84,866
Retained earnings	380,898		376,119
Accumulated other comprehensive income	—		2,203
Total stockholders’ equity	465,294		463,209
Long-term debt, less current portion	431,258		431,092
	896,552		894,301
CURRENT LIABILITIES:
Line of credit	59,000		25,000
Accrued groundwater extraction charges, purchased water and power	18,555		14,382
Accounts payable	26,183		22,960
Accrued interest	6,968		6,869
Accrued property taxes and other non-income taxes	971		1,904
Accrued payroll	4,837		6,011
Other current liabilities	8,037		7,926
	124,551		85,052
DEFERRED INCOME TAXES	84,064		85,795
ADVANCES FOR CONSTRUCTION	80,993		83,695
CONTRIBUTIONS IN AID OF CONSTRUCTION	164,122		160,830
POSTRETIREMENT BENEFIT PLANS	75,229		72,841
REGULATORY LIABILITY	61,639		62,476
OTHER NONCURRENT LIABILITIES	12,971		13,011
COMMITMENTS AND CONTINGENCIES	—		—
	$	1,500,121	1,458,001

See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

SJW Group and Subsidiaries

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

(in thousands)



	Six months ended June 30,
	2018			2017
OPERATING ACTIVITIES:
Net income before noncontrolling interest	$	14,156		24,255
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	28,389			25,258
Deferred income taxes	(2,129		)	1,286
Stock-based compensation	879			1,044
Unrealized loss on California Water Service Group stock	527			—
Gain on sale of real estate investments	—			(6,903	)
Loss on sale of California Water Service Group stock	87			—
Changes in operating assets and liabilities:
Accounts receivable and accrued unbilled utility revenue	(9,359		)	(7,814	)
Accounts payable and other current liabilities	1,414			725
Accrued groundwater extraction charges, purchased water and power	4,173			7,376
Tax payable and receivable, and other accrued taxes	5,607			12,030
Postretirement benefits	2,388			2,651
Regulatory assets and liability related to balancing and memorandum accounts	1,399			(3,031	)
Other changes, net	(2,105		)	114
NET CASH PROVIDED BY OPERATING ACTIVITIES	45,426			56,991
INVESTING ACTIVITIES:
Additions to utility plant:
Company-funded	(62,091		)	(60,921	)
Contributions in aid of construction	(3,091		)	(4,258	)
Additions to real estate investments	(123		)	(119	)
Payments to retire utility plant, net of salvage	(2,787		)	(718	)
Proceeds from sale of real estate investments	—			11,180
Proceeds from sale of California Water Service Group stock	714			—
Payments for business/asset acquisition and water rights	—			(1,150	)
Deposit for long-lived asset held-for-sale	—			3,000
NET CASH USED IN INVESTING ACTIVITIES	(67,378		)	(52,986	)
FINANCING ACTIVITIES:
Borrowings on line of credit	34,000			2,500
Repayments of line of credit	—			(16,700	)
Repayments of long-term borrowings	—			(2,717	)
Payment to noncontrolling interest	—			(1,896	)
Dividends paid	(11,520		)	(8,916	)
Receipts of advances and contributions in aid of construction	4,560			9,052
Refunds of advances for construction	(1,251		)	(1,202	)
Other changes, net	(2,710		)	(248	)
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES	23,079			(20,127	)
NET CHANGE IN CASH AND CASH EQUIVALENTS	1,127			(16,122	)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD	7,799			25,350
CASH AND CASH EQUIVALENTS, END OF PERIOD	$	8,926		9,228
Cash paid during the period for:
Interest	$	13,240		12,382
Income taxes	420			237
Supplemental disclosure of non-cash activities:
Change in accrued payables for construction costs capitalized	1,657			7,985
Utility property installed by developers	565			381

See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

SJW GROUP AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2018

(in thousands, except share and per share data)


Note 1.	General

In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal, recurring adjustments) necessary for a fair presentation of the results for the interim periods.

The unaudited interim financial information has been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and in accordance with the instructions for Form 10-Q and Rule 10-01 of Regulation S-X promulgated by the Securities and Exchange Commission (the “SEC”). The Notes to Consolidated Financial Statements in SJW Group’s 2017 Annual Report on Form 10-K should be read with the accompanying unaudited condensed consolidated financial statements.

Recently Adopted Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) 2014-09, “Revenue from Contracts with Customers.” The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The new standard replaced most existing revenue recognition guidance in generally accepted accounting principles. The updated guidance also requires additional disclosures regarding the nature, timing and uncertainty of revenue transactions. SJW Group adopted the new revenue standard on January 1, 2018, using the modified retrospective method, and determined that no adjustment to the opening balance of retained earnings was necessary for contracts with remaining obligations as of the effective date. In addition, SJW Group applied the “right to invoice” practical expedient. The adoption of the new standard requires certain changes to the recognition of balancing and memorandum account revenue and related costs (See Note 9, “Balancing and Memorandum Accounts”). However, the changes did not have a material impact on our consolidated results of operations, financial position, or cash flows. Concurrently, the company implemented ASU 2017-10, “Identifying the Customer in a Service Concession Arrangement.” Upon adoption of ASU 2017-10, the service concession fee paid to the City of Cupertino was determined to be an up-front payment and accordingly will be amortized as a reduction to future revenue as opposed to amortized as an expense on SJW Group’s Consolidated Statements of Comprehensive Income.

In January 2016, the FASB issued ASU 2016-01, “Financial Instruments - Overall” which changes the recognition of changes in fair value of financial liabilities when the fair value option is elected. In addition, the standard requires equity investments to be measured at fair value with changes in fair value recognized in net income instead of through other comprehensive income. The updated guidance affects the accounting for the company’s equity investment in California Water Service Group stock classified as an available-for-sale security (see Note 7 and Note 11 of “Notes to Unaudited Consolidated Financial Statements”). The new standard became effective for SJW Group beginning in the first quarter of the fiscal year ending December 31, 2018. Prior to adoption of ASU 2016-01, SJW Group recognized changes in fair value of its equity investment in California Water Service Group stock through other comprehensive income or loss on the statement of comprehensive income. Upon adoption on January 1, 2018, SJW Group began recording the change in fair value of its equity investment in other income and expense. In addition, the ASU stated that entities should apply the new standard by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. As such, SJW Group recorded a cumulative-effect adjustment of $2,203 to beginning retained earnings to eliminate the cumulative change in fair value of its equity investment, net of tax from accumulated other comprehensive income.

In October 2016, the FASB issued ASU 2016-16, “Intra-Entity Transfers of Assets Other Than Inventory,” which modifies existing guidance and is intended to reduce diversity in practice with respect to accounting for the income tax consequences of intra-entity transfers of assets. The ASU requires that the current and deferred income tax consequences of intra-entity transfers of assets be immediately recognized. Prior guidance allowed the entities to defer the consolidated tax consequences of an intercompany transfer of an asset other than inventory to a future period and amortize those tax consequences over time. SJW Group adopted ASU 2016-16 effective January 1, 2018. As SJW Group did not have any unamortized tax expense, the company did not have any cumulative catch-up adjustments upon adoption of this ASU.

In March 2017, the FASB issued ASU 2017-07, “Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Costs,” which requires employers to present the service cost component of the net periodic benefit cost in the same income statement line item as other employee compensation costs arising from services rendered during the period. The standard provides that only the service cost component of net periodic pension costs is eligible for asset capitalization. Companies should present the other components of net periodic benefit costs separately from the line items that include the service cost and outside of any subtotal of operating income, if one is presented. ASU 2017-07 requires retrospective

SJW GROUP AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

June 30, 2018

(in thousands, except share and per share data)

presentation in the income statement of the service cost component and the other components of net periodic cost and net periodic postretirement benefit cost and prospective presentation from date of adoption for the capitalization in assets of only the service cost component of net periodic cost and net periodic postretirement benefit cost. SJW Group adopted ASU 2017-07 effective January 1, 2018. As such, the consolidated statements of comprehensive income for the periods presented have been reclassified to reflect the retrospective changes. See Note 4 of “Defined Benefit Plan” for further discussion.

Revenue

Water sales are seasonal in nature and influenced by weather conditions. The timing of precipitation and climatic conditions can cause seasonal water consumption by customers to vary significantly. Due to the seasonal nature of the water business, the operating results for interim periods are not indicative of the operating results for a 12-month period. Revenue is generally higher in the warm, dry summer months when water usage and sales are greater, and lower in the winter months when cooler temperatures and increased rainfall curtail water usage and sales.

On January 1, 2018, SJW Group adopted FASB ASC Topic 606 - “Revenue from Contracts with Customers.” In accordance with Topic 606, management has determined that the company has principally four categories of revenues. The first category, revenue from contracts with customers, represents metered revenue of Water Utility Services which includes billings to customers based on meter readings plus an estimate of water used between the customers’ last meter reading and the end of the accounting period. SJW Group satisfies its performance obligation upon delivery of water to the customer at which time the customer consumes the benefits provided by the company. The customer is typically billed on a bi-monthly basis after water delivery has occurred. The customer is charged both a service charge which is based upon meter size and covers a portion of the fixed costs of furnishing water to the customer and a consumption charge based on actual water usage. Unbilled revenue from the last meter reading date to the end of the accounting period is estimated based on the most recent usage patterns, production records and the effective tariff rates. As the company has the right to bill for services that it has provided, SJW Group estimates the dollar value of deliveries during the unbilled period and recognizes the associated revenue. Actual results could differ from those estimates, which may result in an adjustment to revenue when billed in a subsequent period. The second category, rental income, represents lease rental income from SJW Land Company tenants. The tenants pay monthly in accordance with lease agreements and SJW Group recognizes the income ratably over the lease term as this is the most representative of the pattern in which the benefit is expected to be derived from SJW Group’s underlying asset. The third and fourth revenue categories are other balancing and memorandum accounts and alternative revenue programs. Both are scoped out of Topic 606 and are accounted for under FASB ASC Topic 980 - “Regulated Operations.” Balancing and memorandum accounts are recognized by San Jose Water Company when it is probable that future recovery of previously incurred costs or future refunds that are to be credited to customers will occur through the ratemaking process. In addition, in the case of special revenue programs such as the Water Conservation Memorandum Account (“WCMA”), San Jose Water Company follows the requirements of ASC Topic 980-605-25, “Alternative Revenue Programs” in determining revenue recognition, including the requirement that such revenues will be collected within 24 months of the year-end in which the revenue is recorded. A reserve is recorded for amounts SJW Group estimates will not be collected within the 24-month period. This reserve is based on an estimate of actual usage over the recovery period, offset by applicable drought surcharges. In assessing the probability criteria for balancing and memorandum accounts between general rate cases, San Jose Water Company considers evidence that may exist prior to California Public Utilities Commission (“CPUC”) authorization that would satisfy ASC Topic 980 subtopic 340-25 recognition criteria. Such evidence may include regulatory rules and decisions, past practices, and other facts and circumstances that would indicate that recovery or refund is probable. When such evidence provides sufficient support, the balances are recorded in SJW Group’s financial statements.

From 2014 to 2016, California was in a severe drought. In response to the drought, the State Water Resources Control Board (the “State Water Board”) imposed mandatory water use restrictions and conservation targets. The Santa Clara Valley Water District (“SCVWD”), San Jose Water Company’s principal water supplier, also mandated water use restrictions along with conservation targets at levels higher than the State Water Board. While the Governor of California declared the drought over on April 7, 2017, the State Water Board made certain water use restrictions permanent while SCVWD maintained a conservation target at 20%.

On May 31, 2018, Governor Edmund G. Brown signed into law Assembly Bill 1668 and Senate Bill 606. Both bills set an initial limit for indoor water use of 55 gallons per person per day by 2022 and reduced the limit further to 50 gallons per person per day by 2030. Implementation details remain to be developed as to how local water providers will meet this mandate as well as to how the CPUC will direct its regulated utilities to comply.

SJW GROUP AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

June 30, 2018

(in thousands, except share and per share data)

To encourage conservation, San Jose Water Company received approval from the CPUC to implement a Mandatory Conservation Revenue Adjustment Memorandum Account in 2014. This account was subsequently replaced with a WCMA. The WCMA allows San Jose Water Company to track lost revenue, net of related water costs, associated with reduced sales due to water conservation and associated calls for water use reductions. San Jose Water Company records the lost revenue captured in the WCMA regulatory accounts once the revenue recognition requirements of FASB ASC Topic 980 - “Regulated Operations,” subtopic 605-25 are met. For further discussion, please see Note 8 and Note 9.

The major streams of revenue for SJW Group are as follows:



	Three months ended June 30,					Six months ended June 30,
	2018			2017		2018			2017
Revenue from contracts with customers	$	98,443		95,857		$	174,312		164,424
Alternative revenue programs, net - WCMA	3,933			7,639		3,601			9,915
Other balancing and memorandum accounts revenue, net *	(4,611		)	(2,750	)	(6,447		)	(6,111	)
Rental income	1,321			1,327		2,662			2,890
	$	99,086		102,073		$	174,128		171,118

* The amount reflected for three and six months ended June 30, 2018, excludes a further addition of $1,351 and $1,030, respectively, to revenue related to cost-recovery balancing accounts which upon adoption of Topic 606 are recorded as capitalized costs until recovery is approved by the CPUC. During 2017, prior to adoption of Topic 606, these amounts were recorded as revenue. For further discussion, please see Note 9.

Income Taxes

On December 22, 2017, the Tax Cuts and Jobs Act (H.R. 1) (the “Tax Act”) was signed into law. Among other things, the Tax Act permanently lowers the corporate statutory tax rate to 21% from the previous maximum rate of 35%, effective for tax years including or commencing January 1, 2018. See Note 8 and Note 9, for discussion on the effect of the Tax Act on SJW Group’s regulatory activities.

Earnings per Share

Basic earnings per share is calculated using income available to common stockholders, divided by the weighted average number of shares outstanding during the period. Diluted earnings per share is calculated using income available to common stockholders divided by the weighted average number of shares of common stock including both shares outstanding and shares potentially issuable in connection with deferred restricted common stock awards under SJW Group’s Long-Term Incentive Plan (as amended, the “Incentive Plan”) and shares potentially issuable under the Employee Stock Purchase Plan (“ESPP”). For the three months ended June 30, 2018 and 2017, 2,094 and 981 anti-dilutive restricted common stock units were excluded from the dilutive earnings per share calculation, respectively. For the six months ended June 30, 2018, and 2017, 3,256 and 2,987 anti-dilutive restricted common stock units were excluded from the dilutive earnings per share calculation, respectively.

Utility Plant Depreciation

A portion of depreciation expense is allocated to administrative and general expense. For the three months ended June 30, 2018 and 2017, the amounts allocated to administrative and general expense were $572 and $579, respectively. For the six months ended June 30, 2018, and 2017, the amounts allocated to administrative and general expense were $1,150 and $1,106, respectively.


Note 2.	Equity Plans

SJW Group accounts for stock-based compensation based on the grant date fair value of awards issued to employees in accordance with FASB ASC Topic 718 - “Compensation - Stock Compensation,” which requires the measurement and recognition of compensation expense based on estimated fair value for stock-based payment awards.

The Incentive Plan allows SJW Group to provide employees, non-employee board members or the board of directors of any parent or subsidiary, consultants, and other independent advisors who provide services to the company or any parent or subsidiary the opportunity to acquire an equity interest in SJW Group. The types of awards included in the Incentive Plan are restricted stock awards, restricted stock units, performance stock units, or other stock-based awards. As of June 30, 2018, the remaining number of shares available under the Incentive Plan was 881,914, and an additional 190,405 shares were issuable

SJW GROUP AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

June 30, 2018

(in thousands, except share and per share data)

under outstanding restricted stock units and deferred restricted stock units. In addition, shares are issued to employees under the company’s ESPP.

Stock compensation costs charged to income are recognized on a straight-line basis over the requisite service period. A summary of compensation costs charged to income, proceeds from the exercise of stock options and similar instruments, and the tax benefit realized from stock options and similar instruments exercised, that were recorded to additional paid-in capital and common stock, by award type, are presented below for the three and six months ended June 30, 2018, and 2017.



	Three months ended June 30,			Six months ended June 30,
	2018		2017	2018		2017
Adjustments to additional paid-in capital and common stock for:
Compensation costs charged to income:
ESPP	$	—	—	$	115	100
Restricted stock and deferred restricted stock	392		458	764		944
Total compensation costs charged to income	$	392	458	$	879	1,044
Proceeds from ESPP	$	—	—	$	653	570

Stock, Restricted Stock and Deferred Restricted Stock

On January 2, 2018, service-based restricted stock units covering an aggregate of 12,296 shares of common stock of SJW Group were granted to certain officers of SJW Group and its subsidiaries. The units vest in three equal successive installments upon completion of each year of service with no dividend equivalent rights. Share-based compensation expense of $60.22 per unit which was based on the award grant date fair value is being recognized over the service period beginning in 2018.

On January 30, 2018, certain officers of SJW Group were granted performance-based restricted stock units covering an aggregate target number of SJW Group’s shares of common stock equal to 4,081 that will vest based on the actual attainment of specified performance goals measured for the 2018 calendar year and continued service through December 31, 2018. The number of shares issuable under such units, ranging between 0% to 150% of the target number of shares, is based on the level of actual attainment of specified performance goals. The units do not include dividend equivalent rights. The awards have no market conditions and the stock-based compensation expense of $58.02 per unit which was based on the award grant date fair value is being recognized assuming the performance goals will be attained. As of June 30, 2018, management believes it is probable that the performance goals will be met.

On January 30, 2018, certain officers of SJW Group were granted performance-based restricted stock units covering an aggregate target number of SJW Group’s shares of common stock equal to 5,259 that will vest based on the actual attainment of specified performance goals for the 2020 calendar year and continued service through December 31, 2020. The number of shares issuable under the awards, ranging between 0% to 150% of the target number of shares, is based on the level of actual attainment of specified performance goals. The units do not include dividend equivalent rights. The awards have no market conditions and the stock-based compensation expense of $55.89 per unit which is based on the award grant date fair value is being recognized assuming the performance goals will be attained. As of June 30, 2018, management believes that it is probable that the performance goals will be met.

On January 30, 2018, performance-based restricted stock units were granted to an officer of SJW Group covering a target number of shares of SJW Group’s common stock equal to 6,342 that will vest based on continued service and attainment of specified performance goals over the period from January 1, 2018, to December 31, 2020. The number of shares issuable under the award, ranging between 0% and 200% of the target number of shares, is based on the level of actual attainment of specified performance goals. These units do not include dividend equivalent rights. The fair value of the performance-based restricted stock award was estimated utilizing the Monte Carlo valuation model, using the fair value of SJW Group’s common stock with the effect of market conditions and no dividend yield on the date of grant, and assumes the performance goals will be attained. Stock-based compensation expense is recognized at $63.85 per unit. If such goals are not met and requisite service is not rendered, no compensation cost will be recognized and any recognized compensation cost will be reversed.

On April 25, 2018, restricted stock units covering an aggregate of 7,385 shares of common stock of SJW Group were granted to the non-employee board members of SJW Group. The units vest upon continuous board service through the day immediately preceding the date of the next annual stockholder meeting with no dividend equivalent rights. Stock-based compensation

SJW GROUP AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

June 30, 2018

(in thousands, except share and per share data)

expense of $55.80 per unit, which is based on the award grant date fair value, is being recognized over the service period beginning in 2018.

As of June 30, 2018, the total unrecognized compensation costs related to restricted and deferred restricted stock plans was $2,462. This cost is expected to be recognized over a remaining weighted average period of 1.59 years.

Employee Stock Purchase Plan

The ESPP allows eligible employees to purchase shares of SJW Group’s common stock at 85% of the fair value of shares on the purchase date. Under the ESPP, employees can designate up to a maximum of 10% of their base compensation for the purchase of shares of common stock, subject to certain restrictions. A total of 400,000 shares of common stock were reserved for issuance under the ESPP.

SJW Group’s recorded expenses were $62 and $132 for the three and six months ended June 30, 2018, respectively, and $54 and $117 for the three and six months ended June 30, 2017, respectively, related to the ESPP. The total unrecognized compensation costs related to the semi-annual offering period that ends July 31, 2018, for the ESPP is approximately $23. This cost is expected to be recognized during the third quarter of 2018.


Note 3.	Real Estate Investments

The major components of real estate investments as of June 30, 2018, and December 31, 2017, are as follows:



	June 30, 2018		December 31, 2017
Land	$	13,262	13,262
Buildings and improvements	43,074		42,951
Subtotal	56,336		56,213
Less: accumulated depreciation and amortization	11,730		11,132
Total	$	44,606	45,081

Depreciation and amortization is computed using the straight-line method over the estimated useful lives of the assets, ranging from 7 to 39 years.

On April 6, 2017, 444 West Santa Clara Street, L.P. sold all of its interests in the commercial building and land the partnership owned and operated for $11,000. 444 West Santa Clara Street, L.P. recognized a pre-tax gain on sale of real estate investments of $6,323, after selling expenses of $1,157. SJW Land Company holds a 70% limited interest in 444 West Santa Clara Street, L.P. SJW Land Company and the noncontrolling interest recognized a pre-tax gain on sale of real estate investments of $4,427 and $1,896, respectively, on the transaction. In addition, SJW Land Company sold undeveloped land located in San Jose, California for $1,350 on April 6, 2017. SJW Land Company recognized a pre-tax gain on sale of real estate investments of $580 on the transaction, after selling expenses of $14.


Note 4.	Defined Benefit Plan

San Jose Water Company sponsors a noncontributory defined benefit pension plan for its eligible employees. Employees hired before March 31, 2008, are entitled to receive retirement benefits using a formula based on the employee’s three highest years of compensation (whether or not consecutive). For employees hired on or after March 31, 2008, benefits are determined using a cash balance formula based on compensation credits and interest credits for each employee. Officers hired before March 31, 2008, are eligible to receive additional retirement benefits under the Executive Supplemental Retirement Plan, and officers hired on or after March 31, 2008, are eligible to receive additional retirement benefits under the Cash Balance Executive Supplemental Retirement Plan. Both plans are non-qualified plans in which only officers and other designated members of management may participate. San Jose Water Company also provides health care and life insurance benefits for retired employees under the San Jose Water Company Social Welfare Plan.

SJW GROUP AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

June 30, 2018

(in thousands, except share and per share data)

The components of net periodic benefit costs for San Jose Water Company’s pension plan, its Executive Supplemental Retirement Plan, Cash Balance Executive Supplemental Retirement Plan and Social Welfare Plan for the three and six months ended June 30, 2018, and 2017 are as follows:



	Three months ended June 30,					Six months ended June 30,
	2018			2017		2018			2017
Service cost	$	1,607		1,288		$	3,203		2,614
Interest cost	1,876			1,920		3,753			3,823
Other cost	1,145			1,165		2,278			2,203
Expected return on assets	(2,426		)	(2,053	)	(4,853		)	(4,119	)
	$	2,202		2,320		$	4,381		4,521

Effective January 1, 2018, SJW Group adopted ASU 2017-07, “Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Costs.” The new standard requires retrospective presentation in the income statement of the service cost component and the other components of net periodic pension cost and net periodic postretirement benefit cost and prospective presentation from date of adoption for the capitalization in assets of only the service cost component of net periodic pension cost and net periodic postretirement benefit cost. As of June 30, 2017, utility plant included $265 of pension non-service cost in utility plant. The components of net periodic benefit cost have been recorded in the consolidated statements of comprehensive income as follows:



	Three months ended June 30,			Six months ended June 30,
	2018		2017	2018		2017
Other production expenses	$	426	336	$	849	685
Administrative and general expense	902		723	1,797		1,464
Maintenance expense	279		229	557		465
Pension non-service costs	595		1,032	1,178		1,907
	$	2,202	2,320	$	4,381	4,521

SJW GROUP AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

June 30, 2018

(in thousands, except share and per share data)

The following tables summarize the fair values of plan assets by major categories as of June 30, 2018, and December 31, 2017:



		Fair Value Measurements at June 30, 2018
				Quoted Prices in Active Markets for Identical Assets		Significant Observable Inputs		Significant Unobservable Inputs
Asset Category	Benchmark	Total		(Level 1)		(Level 2)		(Level 3)
Cash and cash equivalents	—	$	5,309	$	5,309	$	—	$	—
Actively Managed (a):
All Cap Equity	Russell 3000 Value	6,450		6,408		42		—
U.S. Large Cap Equity	Russell 1000, Russell 1000 Growth, Russell 1000 Value	52,125		52,125		—		—
U.S. Mid Cap Equity	Russell Mid Cap, Russell Mid Cap Growth, Russell Mid Cap Value	9,628		9,628		—		—
U.S. Small Cap Equity	Russell 2000, Russell 2000 Growth, Russell 2000 Value	9,805		9,805		—		—
Non-U.S. Large Cap Equity	MSCI EAFE	5,759		5,759		—		—
REIT	NAREIT - Equity REIT’S	6,276		—		6,276		—
Fixed Income (b)	(b)	45,153		—		45,153		—
Total		$	140,505	$	89,034	$	51,471	$	—

The Plan has a current target allocation of 55% invested in a diversified array of equity securities to provide long-term capital appreciation and 45% invested in a diversified array of fixed income securities and cash to provide preservation of capital plus generation of income.


(a)	Actively managed portfolio of securities with the goal to exceed the stated benchmark performance.


(b)	Actively managed portfolio of fixed income securities with the goal to exceed the Barclays 1-5 Year Government/Credit, Barclays Intermediate Government/Credit, and Merrill Lynch Preferred Stock Fixed Rate.



		Fair Value Measurements at December 31, 2017
				Quoted Prices in Active Markets for Identical Assets		Significant Observable Inputs		Significant Unobservable Inputs
Asset Category	Benchmark	Total		(Level 1)		(Level 2)		(Level 3)
Cash and cash equivalents	—	$	8,207	$	8,207	$	—	$	—
Actively Managed (a):
All Cap Equity	Russell 3000 Value	6,413		6,376		37		—
U.S. Large Cap Equity	Russell 1000, Russell 1000 Growth, Russell 1000 Value	50,351		50,351		—		—
U.S. Mid Cap Equity	Russell Mid Cap, Russell Mid Cap Growth, Russell Mid Cap Value	9,358		9,358		—		—
U.S. Small Cap Equity	Russell 2000, Russell 2000 Growth, Russell 2000 Value	8,725		8,725		—		—
Non-U.S. Large Cap Equity	MSCI EAFE	5,973		5,973		—		—
REIT	NAREIT - Equity REIT’S	6,143		—		6,143		—
Fixed Income (b)	(b)	44,994		—		44,994		—
Total		$	140,164	$	88,990	$	51,174	$	—


(a)	Actively managed portfolio of securities with the goal to exceed the stated benchmark performance.


(b)	Actively managed portfolio of fixed income securities with the goal to exceed the Barclays 1-5 Year Government/Credit, Barclays Intermediate Government/Credit, and Merrill Lynch Preferred Stock Fixed Rate.

SJW GROUP AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

June 30, 2018

(in thousands, except share and per share data)

In 2018, San Jose Water Company expects to make required and discretionary cash contributions of up to $7,450 to the pension plans and Social Welfare Plan. For the three and six months ended June 30, 2018, $1,420 has been contributed to the pension plans and Social Welfare Plan.


Note 5.	Segment and Non-Tariffed Business Reporting

SJW Group is a holding company with four subsidiaries: (i) San Jose Water Company, a water utility which operates both regulated and non-tariffed businesses, (ii) SJWTX, Inc. which is doing business as Canyon Lake Water Service Company (“CLWSC”), a regulated water utility located in Canyon Lake, Texas, and its consolidated non-tariffed variable interest entity, Acequia Water Supply Corporation, (iii) SJW Land Company and its consolidated variable interest entity, 444 West Santa Clara Street, L.P., which operated a commercial building rental that was sold in April 2017, and (iv) Hydro Sub, Inc., a Connecticut corporation that was formed on March 9, 2018 for the sole purpose of effecting the SJW Group and Connecticut Water Service, Inc. (“CTWS”) proposed merger (see discussion on the proposed merger at Note 12). In November 2017, SJW Group sold all its equity interest in Texas Water Alliance Limited, a non-tariffed water utility operation which had acquired permits and leases necessary to develop a water supply project in Texas. In accordance with FASB ASC Topic 280 - “Segment Reporting,” SJW Group has determined that it has two reportable business segments. The first segment is that of providing water utility and utility-related services to its customers through SJW Group’s subsidiaries, San Jose Water Company, CLWSC, and Texas Water Alliance Limited (up to November 2017), together referred to as “Water Utility Services.” The second segment is property management and investment activity conducted by SJW Land Company, referred to as “Real Estate Services.”

SJW Group’s reportable segments have been determined based on information used by the chief operating decision maker. SJW Group’s chief operating decision maker includes the Chairman, President and Chief Executive Officer, and his senior staff. The senior staff reviews financial information presented on a consolidated basis that is accompanied by disaggregated information about operating revenue, net income and total assets, by subsidiaries.

The following tables set forth information relating to SJW Group’s reportable segments and distribution of regulated and non-tariffed business activities within the reportable segments. Certain allocated assets, revenue and expenses have been included in the reportable segment amounts. Other business activity of SJW Group not included in the reportable segments is included in the “All Other” category.



	For Three Months Ended June 30, 2018
	Water Utility Services			Real Estate Services	All Other*		SJW Group
	Regulated		Non-tariffed	Non-tariffed	Non-tariffed		Regulated	Non-tariffed		Total
Operating revenue	$	95,798	1,967	1,321	—		95,798	3,288		99,086
Operating expense	70,642		1,278	891	3,476		70,642	5,645		76,287
Operating income (loss)	25,156		689	430	(3,476	)	25,156	(2,357	)	22,799
Net income (loss) before noncontrolling interest	15,022		497	296	(2,944	)	15,022	(2,151	)	12,871
Depreciation and amortization	13,272		85	299	—		13,272	384		13,656
Senior note and other interest expense	5,540		—	—	544		5,540	544		6,084
Income tax expense (benefit) in net income	4,650		193	92	(867	)	4,650	(582	)	4,068
Assets	$	1,449,714	3,768	46,756	(117	)	1,449,714	50,407		1,500,121

SJW GROUP AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

June 30, 2018

(in thousands, except share and per share data)



	For Three Months Ended June 30, 2017
	Water Utility Services			Real Estate Services		All Other*		SJW Group
	Regulated		Non-tariffed	Non-tariffed		Non-tariffed		Regulated	Non-tariffed	Total
Operating revenue	$	98,836	1,910	1,327		—		98,836	3,237	102,073
Operating expense	67,285		1,223	942		804		67,285	2,969	70,254
Operating income (loss)	31,551		687	385		(804	)	31,551	268	31,819
Net income (loss) before noncontrolling interest	16,080		320	5,321		(1,137	)	16,080	4,504	20,584
Depreciation and amortization	11,592		142	299		—		11,592	441	12,033
Senior note, mortgage and other interest expense	5,215		—	(3	)	544		5,215	541	5,756
Income tax expense (benefit) in net income	9,908		236	1,988		(168	)	9,908	2,056	11,964
Assets	$	1,398,567	19,358	49,337		3,924		1,398,567	72,619	1,471,186



	For Six Months Ended June 30, 2018
	Water Utility Services			Real Estate Services	All Other*		SJW Group
	Regulated		Non-tariffed	Non-tariffed	Non-tariffed		Regulated	Non-tariffed		Total
Operating revenue	$	168,151	3,315	2,662	—		168,151	5,977		174,128
Operating expense	132,343		2,166	1,740	7,749		132,343	11,655		143,998
Operating income (loss)	35,808		1,149	922	(7,749	)	35,808	(5,678	)	30,130
Net income (loss)	19,817		828	652	(7,141	)	19,817	(5,661	)	14,156
Depreciation and amortization	26,473		168	598	—		26,473	766		27,239
Senior note and other interest expense	11,048		—	—	1,088		11,048	1,088		12,136
Income tax expense (benefit) in net income	5,142		322	186	(2,162	)	5,142	(1,654	)	3,488
Assets	$	1,449,714	3,768	46,756	(117	)	1,449,714	50,407		1,500,121



	For Six Months Ended June 30, 2017
	Water Utility Services			Real Estate Services	All Other*		SJW Group
	Regulated		Non-tariffed	Non-tariffed	Non-tariffed		Regulated	Non-tariffed	Total
Operating revenue	$	165,054	3,174	2,890	—		165,054	6,064	171,118
Operating expense	122,031		2,054	1,890	1,616		122,031	5,560	127,591
Operating income (loss)	43,023		1,120	1,000	(1,616	)	43,023	504	43,527
Net income (loss)	20,029		492	5,681	(1,947	)	20,029	4,226	24,255
Depreciation and amortization	23,252		278	622	—		23,252	900	24,152
Senior note, mortgage and other interest expense	10,640		—	62	1,111		10,640	1,173	11,813
Income tax expense (benefit) in net income	11,701		373	2,116	(658	)	11,701	1,831	13,532
Assets	$	1,398,567	19,358	49,337	3,924		1,398,567	72,619	1,471,186

* The “All Other” category includes the accounts of SJW Group and Hydro Sub, Inc. on a stand-alone basis. For the six months ended June 30, 2018, Hydro Sub, Inc. had no recorded revenue or expenses and as of June 30, 2018, held no assets and had incurred no liabilities. For the six months ended June 30, 2017, the “All Other” category includes the accounts of SJW Group on a stand-alone basis.

SJW GROUP AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

June 30, 2018

(in thousands, except share and per share data)


Note 6.	Long-Term Liabilities and Bank Borrowings

SJW Group’s contractual obligations and commitments include senior notes, mortgages and other obligations. San Jose Water Company, a subsidiary of SJW Group, has received advance deposit payments from its customers on certain construction projects. Refunds of the advance deposit payments constitute an obligation of San Jose Water Company solely.


Note 7.	Fair Value Measurement

The following instruments are not measured at fair value on SJW Group’s condensed consolidated balance sheets as of June 30, 2018, but require disclosure of their fair values: cash and cash equivalents, accounts receivable and accounts payable. The estimated fair value of such instruments as of June 30, 2018, approximates their carrying value as reported on the condensed consolidated balance sheets. The fair value of such financial instruments is determined using the income approach based on the present value of estimated future cash flows. There have been no changes in valuation techniques during the three and six months ended June 30, 2018. The fair value of these instruments would be categorized as Level 2 in the fair value hierarchy, with the exception of cash and cash equivalents, which would be categorized as Level 1. The fair value of pension plan assets is discussed in Note 4.

The fair value of SJW Group’s long-term debt was approximately $492,886 and $537,840 as of June 30, 2018, and December 31, 2017, respectively, and was determined using a discounted cash flow analysis, based on the current rates for similar financial instruments of the same duration and creditworthiness of the company. The book value of the long-term debt was $431,258 and $431,092 as of June 30, 2018, and December 31, 2017, respectively. The fair value of long-term debt would be categorized as Level 2 in the fair value hierarchy.

As of June 30, 2018, and December 31, 2017, the fair value of the company’s investment in California Water Service Group was $3,207 and $4,535, respectively, and would be categorized as Level 1 of the fair value hierarchy. For the three and six months ended June 30, 2018, SJW Group recognized an unrealized gain of $140 and an unrealized loss of $527, respectively, due to the change in fair value of the company’s investment in California Water Service Group.


Note 8.	Regulatory Rate Filings

On January 4, 2018, San Jose Water Company filed General Rate Case Application No. 18-01-004 with the CPUC requesting authority for an increase of revenue of $34,288, or 9.76%, in 2019, $14,232, or 3.70%, in 2020 and $20,582, or 5.17%, in 2021. Among other things, the application also includes requests to recover $20,725 from balancing and memorandum accounts, the establishment of a Water Revenue Adjustment Mechanism and Sales Reconciliation Mechanism, and a shift to greater revenue collection in the service charge. On June 28, 2018, the CPUC issued an order in the case identifying the issues to be considered, including whether the proposed merger between SJW Group and Connecticut Water Service, Inc. will have any ratemaking impact on the customers of San Jose Water Company (see discussion on the proposed merger at Note 12). The application is in a year-long review process and new rates, if approved, are expected to become effective January 1, 2019.

On March 14, 2018, San Jose Water Company filed Advice Letter No. 517 to update its Cost of Capital Memorandum Account, which tracks the difference between current water rates and those adopted in Decision 18-03-035. This was approved on April 4, 2018.

The CPUC directed its Class A water utilities, including San Jose Water Company, to reflect the changes to the Internal Revenue Code resulting from the passage of the Tax Act in customer rates. On May 8, 2018, the CPUC directed San Jose Water Company to file an advice letter to implement a change in water rates to reflect the lower income tax rate provided by the Tax Act, effective July 1, 2018. On May 23, 2018, San Jose Water Company filed Advice Letter No. 522 in compliance with the CPUC’s directive. On June 7, 2018, San Jose Water Company filed Advice Letter No. 522A amending the rate change to reflect a reduction in revenue requirement for 2018 of $14,801 or 3.89%, with no impact on after tax income. This request became effective July 1, 2018.

On June 13, 2018, San Jose Water Company filed Advice Letter No. 523 with the CPUC requesting authorization to implement surcharges to offset the increases to purchased potable water charges, the ground water extraction fee, and purchased recycled water charges implemented by the Santa Clara Valley Water District and South Bay Water Recycling effective July 1, 2018. The increases amount to a revenue increase of $13,732 or 3.75%. This request became effective July 1, 2018.

SJW GROUP AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

June 30, 2018

(in thousands, except share and per share data)

San Jose Water Company filed Advice Letter No. 524 with the CPUC on July 26, 2018, requesting authorization to recover the 2017 capital additions related to the Montevina Water Treatment Plant Upgrade Project. The filing requests a revenue increase of $3,155 or 0.83% and is anticipated to become effective on or about August 25, 2018, pending the CPUC’s approval.

The Public Utilities Commission of Texas (“PUCT”) directed CLWSC (as well as other Class A water utilities in Texas) to quantify all of the impacts of the passage of the Tax Act and make rate adjustments reflecting such impacts on a prospective basis. PUCT Order 47945-36 as amended by 47945-41 orders the water utilities to record a regulatory liability that reflects (1) the difference between the revenues collected under existing rates and the revenues that would have been collected had the existing rates been set using the recently approved federal income tax rates; and (2) the balance of excess accumulated deferred federal income taxes that now exists because of the decrease in the federal income tax rate from 35% to 21%. A rate proposal reflecting these tax changes was submitted for PUCT’s review on April 19, 2018.

CLWSC subsequently amended their filing on April 30, 2018 to update the customer notice, and to replace estimates for April with recorded April 2018 information. This filing will return to the ratepayers the difference between the revenues collected under the existing rates and what water rates would have been using the 21% federal income tax rate now effective under the Tax Act. The accrued amounts for the period January 25, 2018 through April 30, 2018 were refunded along with the regular monthly Federal Tax Cut Credit (“FTCC”) on bills prepared during the month of June. The FTCC customer credit will continue to be reflected on customer bills every month until the implementation of new rates resulting from the next rate case. It is projected this credit will reduce water revenue by $1,023 in 2018 with no impact on after tax income.


Note 9.	Balancing and Memorandum Accounts

San Jose Water Company has established balancing accounts for the purpose of tracking the under-collection or over-collection associated with expense changes and the revenue authorized by the CPUC to offset those expense changes. San Jose Water Company also maintains memorandum accounts to track revenue impacts due to catastrophic events, certain unforeseen water quality expenses related to new federal and state water quality standards, energy efficiency, water conservation, water tariffs, and other approved activities or as directed by the CPUC, such as the Tax Act memorandum account.

Balancing and memorandum accounts are recognized by San Jose Water Company when it is probable that future recovery of previously incurred costs or future refunds that are to be credited to customers will occur through the ratemaking process. In addition, in the case of special revenue programs such as the WCMA, San Jose Water Company follows the requirements of ASC Topic 980-605-25, “Alternative Revenue Programs” in determining revenue recognition, including the requirement that such revenues will be collected within 24 months of the year-end in which the revenue is recorded. A reserve is recorded for amounts SJW Group estimates will not be collected within the 24-month period. This reserve is based on an estimate of actual usage over the recovery period, offset by applicable drought surcharges, if any. In assessing the probability criteria for balancing and memorandum accounts between general rate cases, San Jose Water Company considers evidence that may exist prior to CPUC authorization that would satisfy ASC Topic 980 subtopic 340-25 recognition criteria. Such evidence may include regulatory rules and decisions, past practices, and other facts and circumstances that would indicate that recovery or refund is probable. When such evidence provides sufficient support, the balances are recorded in SJW Group’s financial statements.

Based on ASC Topic 980-605-25, San Jose Water Company recognized regulatory assets of $4,118 and $3,410 due to lost revenues accumulated in the 2018 WCMA account for the three and six months ended June 30, 2018, respectively. Of the $4,118 and $3,410 recognized in the 2018 WCMA account for the three and six months ended June 30, 2018, respectively, a reserve of $407 was recorded which is the estimated amount that will not be collected within the 24-month period, as required by the guidance. The amounts have been reflected in the 2018 WCMA balance shown in the table below.

Cost of capital memorandum account was approved by the CPUC on March 14, 2018. The account tracks the difference between current water rates and the lower rates adopted in the cost of capital decision on March 22, 2018. San Jose Water Company recorded a regulatory liability of $198 and $1,363 in the cost of capital memorandum account for the three and six months ended June 30, 2018, respectively, with a corresponding reduction to revenue. The amount has been reflected in the cost of capital memorandum account balance shown in the table below.

The CPUC directed San Jose Water Company to establish a memorandum account to capture the impact of the Tax Act on its regulated revenue requirement. The CPUC indicated that any benefit from implementing the new law should ultimately be passed on to ratepayers. Accordingly, San Jose Water Company recorded a regulatory liability of $4,563 and $5,496 in the tax

SJW GROUP AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

June 30, 2018

(in thousands, except share and per share data)

memorandum account for the three and six months ended June 30, 2018, respectively, with a corresponding reduction to revenue. The amount has been reflected in the tax memorandum account balance shown in the table below.

San Jose Water Company re-evaluated the accounting for cost-recovery balancing and memorandum accounts under the new revenue recognition guidance, ASU 2014-09, “Revenue from Contracts with Customers.” Prior to adoption, San Jose Water Company recorded cost-recovery accounts as a component of revenue. Upon adoption of ASU 2014-09, San Jose Water Company began recording such balances as capitalized costs until recovery is approved by the CPUC. The change is reflected in the cost-recovery balancing and memorandum accounts as shown in the table below.



	Three months ended June 30, 2018									Three months ended June 30, 2017
	Beginning Balance			Regulatory Asset Increase (Decrease)		Refunds (Collections)	Surcharge Offset	Ending Balance		Beginning Balance			Regulatory Asset Increase (Decrease)	Refunds (Collections)		Surcharge Offset		Ending Balance

Revenue accounts:
2014-2016 WCMA	$	270		93		2	—	365		$	398		3,206	(556	)	(45	)	3,003
2017 WCMA*	6,785			127		—	—	6,912		—			4,989	—		(3,988	)	1,001
2018 WCMA*	(708		)	3,711		—	—	3,003		—			—	—		—		—
2012 General Rate Case true-up	11,320			—		4	—	11,324		18,424			—	(2,659	)	—		15,765
2015 General Rate Case true-up	115			—		2	—	117		4,097			—	(1,686	)	—		2,411
Cost of capital memorandum account	(1,309		)	(198	)	—	—	(1,507	)	(459		)	—	315		—		(144	)
Tax memorandum account	(933		)	(4,563	)	—	—	(5,496	)	—			—	—		—		—
Drought surcharges	—			—		—	—	—		(5,054		)	—	60		4,033		(961	)
Cost-recovery accounts	—			—		—	—	—		3,145			1,631	(369	)	—		4,407
All others	4,136			422		—	—	4,558		3,516			426	(408	)	—		3,534
Total revenue accounts	$	19,676		(408	)	8	—	19,276		$	24,067		10,252	(5,303	)	—		29,016
Cost-recovery accounts:
Water supply costs	8,197			1,190		—	—	9,387		—			—	—		—		—
Pension	(2,298		)	161		—	—	(2,137	)	—			—	—		—		—
Total cost-recovery accounts	$	5,899		1,351		—	—	7,250		$	—		—	—		—		—

Total	$	25,575		943		8	—	26,526		$	24,067		10,252	(5,303	)	—		29,016

SJW GROUP AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

June 30, 2018

(in thousands, except share and per share data)



	Six months ended June 30, 2018									Six months ended June 30, 2017
	Beginning Balance			Regulatory Asset Increase (Decrease)		Refunds (Collections)	Surcharge Offset	Ending Balance		Beginning Balance			Regulatory Asset Increase (Decrease)	Refunds (Collections)		Surcharge Offset		Ending Balance

Revenue accounts:
2014-2016 WCMA	$	190		173		2	—	365		$	1,589		4,654	(1,788	)	(1,452	)	3,003
2017 WCMA*	6,489			423		—	—	6,912		—			7,049	—		(6,048	)	1,001
2018 WCMA*	—			3,003		—	—	3,003		—			—	—		—		—
2012 General Rate Case true-up	11,320			—		4	—	11,324		20,682			—	(4,917	)	—		15,765
2015 General Rate Case true-up	115			—		2	—	117		5,528			—	(3,117	)	—		2,411
Cost of capital memorandum account	(144		)	(1,363	)	—	—	(1,507	)	(817		)	—	673		—		(144	)
Tax memorandum account	—			(5,496	)	—	—	(5,496	)	—			—	—		—		—
Drought surcharges	—			—		—	—	—		(7,688		)	—	(773	)	7,500		(961	)
Cost-recovery accounts	—			—		—	—	—		3,181			2,001	(775	)	—		4,407
All others	3,736			822		—	—	4,558		3,434			883	(859	)	76		3,534
Total revenue accounts	$	21,706		(2,438	)	8	—	19,276		$	25,909		14,587	(11,556	)	76		29,016
Cost-recovery accounts:
Water supply costs	8,679			708		—	—	9,387		—			—	—		—		—
Pension	(2,459		)	322		—	—	(2,137	)	—			—	—		—		—
Total cost-recovery accounts	$	6,220		1,030		—	—	7,250		$	—		—	—		—		—

Total	$	27,926		(1,408	)	8	—	26,526		$	25,909		14,587	(11,556	)	76		29,016

* As of June 30, 2018, the reserve balances for the 2017 and 2018 WCMA were $938 and $407, respectively, which have been netted from the balances above. As of June 30, 2017, the reserve balance for the 2017 WCMA was $276 which has been netted from the balance above.

As of June 30, 2018, the total balance in San Jose Water Company’s balancing and memorandum accounts combined, including interest, that has not been recorded into the financial statements was a net under-collection of $3,900. All balancing accounts and memorandum-type accounts not included for recovery or refund in the current general rate case will be reviewed by the CPUC in San Jose Water Company’s next general rate case or at the time an individual account reaches a threshold of 2% of authorized revenue, whichever occurs first.

SJW GROUP AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

June 30, 2018

(in thousands, except share and per share data)


Note 10.	Regulatory Assets and Liabilities

Regulatory assets and liabilities are comprised of the following as of June 30, 2018 and December 31, 2017:



	June 30, 2018		December 31, 2017
Regulatory assets:
Postretirement pensions and other medical benefits	$	68,556	68,556
Balancing and memorandum accounts, net	26,526		27,925
Other, net	3,250		3,073
Total regulatory assets, net in Consolidated Balance Sheets	$	98,332	99,554

Regulatory liability:
Income tax temporary differences, net	$	61,639	62,476
Total regulatory liability in Consolidated Balance Sheets	$	61,639	62,476


Note 11.	California Water Service Group Stock

During the quarter ended March 31, 2018, SJW Group sold 17,660 shares of California Water Service Group for $716, before fees of $2. SJW Group recognized a loss on the sale of the stock of approximately $87 and tax benefit of approximately $24, for a net loss of $63. As of June 30, 2018, SJW Group held 82,340 shares of California Water Service Group remaining. The company classifies its investment in California Water Service Group as available for sale. The stock is carried at the quoted market price with the changes in gain or loss reported as a component of other expense (income) on the Consolidated Statements of Comprehensive Income.


Note 12.	SJW Group and CTWS Merger Agreement

On March 14, 2018, SJW Group, Hydro Sub, Inc., a Connecticut corporation and a wholly-owned subsidiary of SJW Group and CTWS entered into an Agreement and Plan of Merger with regard to an all-stock transaction. On May 30, 2018, SJW Group, Hydro Sub, Inc. and CTWS entered into an Amended and Restated Agreement & Plan of Merger (the “Merger Agreement”), which provided, among other things, CTWS the right to solicit alternative proposals from third parties and take certain other actions relating to a “go-shop process” through July 14, 2018. Under the terms of the Merger Agreement, Hydro Sub, Inc. will merge with and into CTWS (the “Merger”), with CTWS surviving the Merger as a wholly-owned subsidiary of SJW Group. Subject to the terms and conditions of the Merger Agreement, at the time at which the Merger becomes effective (the “Effective Time”), each share of common stock, without par value, of CTWS (“CTWS Common Share”), other than CTWS Common Shares directly or indirectly owned by the company, Hydro Sub, Inc., CTWS or any of their respective subsidiaries (in each case, other than any CTWS Common Shares held on behalf of third parties), issued and outstanding immediately prior to the Effective Time will be converted into the right to receive 1.1375 shares of common stock of SJW Group, par value $0.001.

The transaction, which is expected to close during the fourth quarter of 2018, has been unanimously approved by the boards of directors of both companies. Consummation of the Merger is subject to customary conditions, including, without limitation: approval by SJW Group's stockholders and CTWS shareholders, approval by certain regulators, the approval by the New York Stock Exchange of the listing of common stock of SJW Group to be issued as consideration in the Merger; the absence of any law or judgment prohibiting the consummation of the Merger or the Charter Amendment; the effectiveness of the registration statement on Form S-4 relating to the shares of common stock to be issued in the Merger; the accuracy of the representations and warranties of the parties (subject to customary materiality qualifiers); each party’s performance in all material respects of its obligations contained in the Merger Agreement; the absence of any material adverse effect on the company or CTWS since the date of the Merger Agreement, which has not been ameliorated or cured; and the receipt by each party of customary opinions from counsel to the effect that the Merger will qualify as a reorganization for U.S. federal income tax purposes. There is no guarantee that all of the closing conditions and approvals will be satisfied, and the failure to complete the proposed merger may adversely affect the financial conditions and results of operations of SJW Group.

In addition, SJW Group and CTWS have each received an unsolicited proposal. While each of the companies’ board of directors has determined that the respective proposals were neither superior proposals nor reasonably likely to lead to superior

SJW GROUP AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

June 30, 2018

(in thousands, except share and per share data)

proposals, California Water Service Group filed on May 2, 2018 a preliminary proxy statement and on May 31, 2018 a definitive proxy statement to solicit proxies in opposition to the proposed merger, Eversource Energy filed on April 27, 2018 a preliminary proxy statement to solicit proxies in opposition to the proposed merger, and it is unclear what additional actions these third parties may take to further their proposals. In addition, on June 7, 2018, California Water Service Group filed a Schedule TO with the SEC and issued a press release announcing that it had commenced an unsolicited tender offer to acquire all outstanding shares of SJW Group for $68.25 per share in cash, following which, on June 15, 2018, SJW Group filed a Schedule 14D-9 with the SEC and issued a press release announcing the SJW Group board of director’s recommendation that stockholders reject the California Water Service Group tender offer and not tender their shares into the California Water Service Group tender offer and reaffirming SJW Group’s commitment to the proposed merger.


Note 13.	Legal Proceedings

On June 14, 2018, certain shareholders of CTWS filed two nearly identical class-action complaints in Connecticut state court against the CTWS board of directors, SJW Group, and Eric W. Thornburg, Chairman, President and Chief Executive Officer of SJW Group, CTWS and the Merger. The complaints allege that the CTWS board breached its fiduciary duties in connection with the Merger and that SJW Group and Mr. Thornburg aided and abetted such breaches. Among other remedies, the actions seek to recover rescissory and other damages and attorney’s fees and costs. SJW Group believes the claims in these complaints are without merit and intends to vigorously defend this litigation. At this time, SJW Group cannot determine the likelihood that liability exists on the part of SJW Group or Mr. Thornburg and we are unable to provide a reasonable estimate of potential loss, if any.

SJW Group is subject to ordinary routine litigation incidental to its business. There are no pending legal proceedings to which SJW Group or any of its subsidiaries is a party, or to which any of its properties is the subject, that are expected to have a material effect on SJW Group’s business, financial position, results of operations or cash flows.


Note 14.	Subsequent Event

CLWSC completed its acquisition of the Deer Creek Ranch Water Co., LLC’s water system on July 2, 2018 for a purchase price of $2,700. In 2017, CLWSC entered into an agreement to purchase the water system assets. Deer Creek Ranch includes approximately 750 service connections over an area of 1,191 acres in the Texas Hill Country on the rapidly growing western fringe of the Austin metropolitan area, about 40 miles south of CLWSC’s operating area of New Braunfels.


ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Dollar amounts in thousands, except per share amounts and otherwise noted)

The information in this Item 2 should be read in conjunction with the financial information and the notes thereto included in Item 1 of this Form 10-Q and the consolidated financial statements and notes thereto and the related “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in SJW Group’s Annual Report on Form 10-K for the year ended December 31, 2017.

This report contains forward-looking statements within the meaning of the federal securities laws relating to future events and future results of SJW Group and its subsidiaries that are based on current expectations, estimates, forecasts, and projections about SJW Group and its subsidiaries and the industries in which SJW Group and its subsidiaries operate and the beliefs and assumptions of the management of SJW Group. Such forward-looking statements are identified by words including “expect,” “estimate,” “anticipate,” “intends,” “seeks,” “plans,” “projects,” “may,” “should,” “will,” and variation of such words, and similar expressions. These forward-looking statements are only predictions and are subject to risks, uncertainties and assumptions that are difficult to predict. Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements. Important factors that could cause or contribute to such differences include, but are not limited to, those discussed in this report and our most recent Form 10-K and Form S-4 filed with the Securities and Exchange Commission (the “SEC”) under the items entitled “Risk Factors,” and in other reports SJW Group files with the SEC, specifically the most recent reports on Form 10-Q and Form 8-K, each as it may be amended from time to time. SJW Group undertakes no obligation to update or revise the information contained in this report, including the forward-looking statements, to reflect any event or circumstance that may arise after the date of this report.

General:

SJW Group is a holding company with four wholly-owned subsidiaries: San Jose Water Company, SJWTX, Inc., SJW Land Company and Hydro Sub, Inc.

San Jose Water Company is a public utility in the business of providing water service to approximately 230,000 connections that serve a population of approximately one million people in an area comprising approximately 138 square miles in the metropolitan San Jose, California area.

The principal business of San Jose Water Company consists of the production, purchase, storage, purification, distribution, wholesale and retail sale of water. San Jose Water Company provides water service to customers in portions of the cities of San Jose and Cupertino and in the cities of Campbell, Monte Sereno, Saratoga and the Town of Los Gatos, and adjacent unincorporated territories, all in the County of Santa Clara in the State of California. San Jose Water Company distributes water to customers in accordance with accepted water utility methods which include pumping from storage and gravity feed from high elevation reservoirs. San Jose Water Company also provides non-tariffed services under agreements with municipalities and other utilities. These non-tariffed services include water system operations, maintenance agreements and antenna site leases.

San Jose Water Company has utility property including land held in fee, impounding reservoirs, diversion facilities, wells, distribution storage, and all water facilities, equipment, office buildings and other property necessary to supply its customers. Under Section 851 of the California Public Utilities Code, properties currently used and useful in providing utilities services cannot be disposed of unless California Public Utilities Commission (“CPUC”) approval is obtained.

San Jose Water Company also has approximately 411 acres of nonutility property which has been identified as no longer used and useful in providing utility services. The majority of the properties are located in the hillside areas adjacent to San Jose Water Company’s various watershed properties.

SJWTX, Inc., doing business as Canyon Lake Water Service Company (“CLWSC”), is a public utility in the business of providing water service to approximately 14,700 connections that serve approximately 44,000 people. CLWSC’s service area comprises more than 246 square miles in western Comal County and southern Blanco County in the growing region between San Antonio and Austin, Texas. SJWTX, Inc. has a 25% interest in Acequia Water Supply Corporation (“Acequia”). The water supply corporation has been determined to be a variable interest entity within the scope of ASC Topic 810 with SJWTX, Inc. as the primary beneficiary. As a result, Acequia has been consolidated with SJWTX, Inc.

SJW Land Company owned the following real properties during the six months ended June 30, 2018:



				% for Six months ended June 30, 2018 of SJW Land Company
Description	Location	Acreage	Square Footage	Revenue		Expense
Warehouse building	Knoxville, Tennessee	30	361,500	43	%	41	%
Commercial building	Knoxville, Tennessee	15	135,000	57	%	59	%
Undeveloped land and parking lot	Knoxville, Tennessee	10	N/A	N/A		N/A