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

2



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.

3



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.

4



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.

5



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

6


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.

7


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

8


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

9


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.

10


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


11


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

 
$

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.

12


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


13


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.


14


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.

15


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 PUCTs 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

16


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



17


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.


18


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

19


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.


20



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.


21



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