Edgar Filing: SJW GROUP

Large accelerated filer ☐

Accelerated filer ☒

Non-accelerated filer ☐

Smaller reporting company ☐

(Do not check if a smaller reporting company)

Emerging growth company ☐

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. ☐

Document

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, 2017

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 ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§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 ☒ No ☐

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 ☐ No ☒

APPLICABLE ONLY TO CORPORATE ISSUERS:

As of July 24, 2017, there were 20,506,494 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,
	2017			2016		2017			2016
OPERATING REVENUE	$	102,073		86,944		$	171,118		148,056
OPERATING EXPENSE:
Production Expenses:
Purchased water	22,181			14,485		36,105			24,182
Power	1,704			1,614		2,991			2,851
Groundwater extraction charges	10,932			8,312		18,342			14,760
Other production expenses	3,655			3,272		7,166			6,504
Total production expenses	38,472			27,683		64,604			48,297
Administrative and general	13,412			11,536		26,017			23,241
Maintenance	4,258			4,054		7,919			7,865
Property taxes and other non-income taxes	3,111			2,684		6,806			5,902
Depreciation and amortization	12,033			11,187		24,152			22,370
Total operating expense	71,286			57,144		129,498			107,675
OPERATING INCOME	30,787			29,800		41,620			40,381
OTHER (EXPENSE) INCOME:
Interest on long-term debt	(5,696		)	(5,007	)	(11,659		)	(10,046	)
Mortgage and other interest expense	(60		)	(462	)	(154		)	(858	)
Gain on sale of California Water Service Group stock	—			3,197		—			3,197
Gain on sale of real estate investments	6,903			—		6,903			—
Dividend income	18			8		36			53
Other, net	596			150		1,041			459
Income before income taxes	32,548			27,686		37,787			33,186
Provision for income taxes	11,964			10,911		13,532			13,033
NET INCOME BEFORE NONCONTROLLING INTEREST	20,584			16,775		24,255			20,153
Less net income attributable to the noncontrolling interest	1,896			—		1,896			—
SJW GROUP NET INCOME	18,688			16,775		22,359			20,153
Other comprehensive income, net of tax:
Unrealized gain on investment	56			487		172			1,017
Reclassification adjustment for gain realized on sale of investments	—			(1,742	)	—			(1,742	)
SJW GROUP COMPREHENSIVE INCOME	$	18,744		15,520		$	22,531		19,428
SJW GROUP EARNINGS PER SHARE
Basic	$	0.91		0.82		$	1.09		0.99
Diluted	$	0.90		0.82		$	1.08		0.98
DIVIDENDS PER SHARE	$	0.22		0.20		$	0.44		0.41
WEIGHTED AVERAGE SHARES OUTSTANDING
Basic	20,504,357			20,437,612		20,495,211			20,425,678
Diluted	20,673,775			20,578,585		20,664,556			20,569,790

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, 2017		December 31, 2016
ASSETS
Utility plant:
Land	$	18,073	17,923
Depreciable plant and equipment	1,575,892		1,554,016
Construction in progress	110,396		70,453
Intangible assets	25,165		23,989
	1,729,526		1,666,381
Less accumulated depreciation and amortization	535,346		520,018
	1,194,180		1,146,363
Real estate investments	56,226		62,193
Less accumulated depreciation and amortization	10,545		11,734
	45,681		50,459
CURRENT ASSETS:
Cash and cash equivalents	9,220		6,349
Restricted cash	8		19,001
Accounts receivable:
Customers, net of allowances for uncollectible accounts	19,643		16,361
Income tax	—		9,796
Other	1,038		3,383
Accrued unbilled utility revenue	31,132		24,255
Current regulatory assets, net	7,672		16,064
Other current assets	4,179		4,402
	72,892		99,611
OTHER ASSETS:
Investment in California Water Service Group	3,680		3,390
Net regulatory assets, less current portion	147,132		135,709
Other	7,621		7,844
	158,433		146,943
	$	1,471,186	1,443,376

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, 2017		December 31, 2016
CAPITALIZATION AND LIABILITIES
CAPITALIZATION:
Stockholders’ equity:
Common stock, $0.001 par value; authorized 36,000,000 shares; issued and outstanding shares 20,506,494 on June 30, 2017 and 20,456,225 on December 31, 2016	$	21	21
Additional paid-in capital	82,622		81,715
Retained earnings	351,771		338,386
Accumulated other comprehensive income	1,696		1,524
Total stockholders’ equity	436,110		421,646
Long-term debt, less current portion	430,926		433,335
	867,036		854,981
CURRENT LIABILITIES:
Line of credit	—		14,200
Current portion of long-term debt	—		125
Accrued groundwater extraction charges, purchased water and power	18,222		10,846
Accounts payable	27,060		18,739
Accrued interest	6,823		6,309
Accrued property taxes and other non-income taxes	947		1,681
Accrued payroll	4,540		4,696
Non-refundable deposit	3,000		—
Income tax payable	2,407		—
Other current liabilities	7,397		6,977
	70,396		63,573
DEFERRED INCOME TAXES	206,503		205,203
ADVANCES FOR CONSTRUCTION	87,223		84,815
CONTRIBUTIONS IN AID OF CONSTRUCTION	154,441		151,576
POSTRETIREMENT BENEFIT PLANS	72,828		70,177
OTHER NONCURRENT LIABILITIES	12,759		13,051
COMMITMENTS AND CONTINGENCIES	—		—
	$	1,471,186	1,443,376

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,
	2017			2016
OPERATING ACTIVITIES:
Net income before noncontrolling interest	$	24,255		20,153
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	25,258			23,204
Deferred income taxes	1,286			10,049
Share-based compensation	1,044			852
Gain on sale of real estate investments	(6,903		)	—
Gain on sale of California Water Service Group stock	—			(3,197	)
Changes in operating assets and liabilities:
Accounts receivable and accrued unbilled utility revenue	(7,814		)	(7,489	)
Accounts payable and other current liabilities	725			(1,012	)
Accrued groundwater extraction charges, purchased water and power	7,376			3,553
Tax payable and receivable, and other accrued taxes	12,030			6,141
Postretirement benefits	2,651			2,848
Regulatory assets and liability related to balancing and memorandum accounts	(3,031		)	(780	)
Other changes, net	114			1,049
NET CASH PROVIDED BY OPERATING ACTIVITIES	56,991			55,371
INVESTING ACTIVITIES:
Additions to utility plant:
Company-funded	(62,037		)	(62,859	)
Contributions in aid of construction	(3,142		)	(3,286	)
Additions to real estate investments	(119		)	(248	)
Payments for business/asset acquisition and water rights	(1,150		)	(1,060	)
Payments to retire utility plant, net of salvage	(718		)	(808	)
Proceeds from sale of real estate investments	11,180			—
Proceeds from non-refundable deposit	3,000			—
Proceeds from sale of California Water Service Group stock	—			4,510
NET CASH USED IN INVESTING ACTIVITIES	(52,986		)	(63,751	)
FINANCING ACTIVITIES:
Borrowings on line of credit	2,500			33,875
Repayments of line of credit	(16,700		)	(12,550	)
Repayments of long-term borrowings	(2,717		)	(4,885	)
Payment to noncontrolling interest	(1,896		)	—
Dividends paid	(8,916		)	(8,274	)
Receipts of advances and contributions in aid of construction	9,052			8,750
Refunds of advances for construction	(1,202		)	(1,164	)
Other changes, net	(248		)	(93	)
NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES	(20,127		)	15,659
NET CHANGE IN CASH, CASH EQUIVALENTS AND RESTRICTED CASH	(16,122		)	7,279
CASH, CASH EQUIVALENTS AND RESTRICTED CASH, BEGINNING OF PERIOD	25,350			5,239
CASH, CASH EQUIVALENTS AND RESTRICTED CASH, END OF PERIOD	$	9,228		12,518
Cash paid (received) during the period for:
Interest	$	12,382		11,943
Income taxes	237			(3,783	)
Supplemental disclosure of non-cash activities:
Increase in accrued payables for construction costs capitalized	7,985			9,061
Utility property installed by developers	381			3,907
RECONCILIATION TO CONSOLIDATED BALANCE SHEETS:
Cash and cash equivalents	9,220			12,518
Restricted cash	8			—
CASH, CASH EQUIVALENTS AND RESTRICTED CASH, END OF PERIOD	$	9,228		12,518

See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

SJW GROUP AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2017

(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 2016 Annual Report on Form 10-K should be read with the accompanying unaudited condensed consolidated financial statements.

In March 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-09, “Improvements to Employee Share-Based Payment Accounting.” This ASU affects entities that issue share-based payment awards to their employees. ASU 2016-09 identifies areas for simplification involving several aspects of accounting for share-based payment transactions, including income tax consequences, classification of awards as either equity or liabilities, classifications on the statement of cash flows and forfeiture rate calculations. SJW Group adopted this standard as of the first quarter of 2017. ASU 2016-09 requires recognition of excess tax benefits and deficiencies in the income statement, which resulted in the recognition of $500 in income tax benefit for the three months ended March 31, 2017. Prior to adoption, these amounts were recognized as additional paid-in capital. SJW Group did not have any unrecognized excess tax benefits to reclassify upon adoption of this standard. The ASU also requires excess tax benefits and deficiencies to be prospectively excluded from assumed future proceeds in the calculation of diluted shares when calculating diluted earnings per shares using the treasury stock method. The effect of this change on diluted earnings per share was immaterial. In addition, excess income tax benefits from share-based compensation are now classified as cash flows from operating activities on the consolidated statements of cash flows, prospectively. Further, ASU 2016-09 requires, on a retrospective basis, that employee taxes paid for withheld shares be classified as cash flows from financing activities rather than cash flows from operating activities. As such, the consolidated statements of cash flows for SJW Group for the periods presented have been reclassified to reflect this change. This change resulted in an increase to cash flows from operating activities and a decrease to cash flows from financing activities of $815 and $486 for the three months ended March 31, 2017 and 2016, respectively. SJW Group has elected to account for actual forfeitures as they occur upon adoption of the new guidance. Management determined that the cumulative effect adjustment required under the new guidance was immaterial and therefore SJW Group did not record an adjustment.

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 May 9, 2016, Governor Brown issued Executive Order B-37-16 to build on existing temporary statewide emergency water restrictions and to establish longer term water conservation measures, including permanent monthly water use reporting, new permanent water use standards in California communities and bans on clearly wasteful practices. On May 18, 2016, the State Water Board adopted a new approach to water conservation regulation and replaced its prior percentage reduction-based water conservation standard with a new approach designed to ensure at least a three year supply of available water based on local conditions. On June 14, 2016, the Santa Clara Valley Water District (“SCVWD”) reduced its conservation target from 30% to 20% and also increased the number of allowable outdoor watering days from two to three effective July 1, 2016 through January 31, 2017. On January 24, 2017, and again on June 13, 2017, the SCVWD reaffirmed their call for 20% conservation and restrictions on outdoor watering for ornamental landscapes to no more than three days a week. On April 7, 2017, Governor Brown issued Executive Order B-40-17 which lifted the drought emergency in all California counties except Fresno, Kings, Tulare, and Tuolumne while maintaining water reporting requirements and prohibitions on wasteful practices. Executive Order B-40-17 also rescinded two emergency proclamations from January and April 2014 and four drought-related executive orders issued in 2014 and 2015. Restrictions imposed by SCVWD remain in effect.

Effective June 15, 2015, San Jose Water Company was authorized by the CPUC to activate Stage 3 of Tariff Rule 14.1 which is a water shortage contingency plan with mandatory water usage reductions and drought surcharges resulting from usage above customer allocations. Tariff Rule 14.1 focuses primarily on restrictions of outdoor water use which accounts for 50% of a typical customer’s water usage. On June 24, 2016, San Jose Water Company filed with the CPUC to amend its water shortage contingency plan with mandatory water usage reductions and drought surcharges to reflect the SCVWD’s call for 30%

SJW GROUP AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

June 30, 2017

(in thousands, except share and per share data)

conservation. This request was approved by the CPUC with an effective date of July 1, 2016. The drought surcharges were not recorded as revenue. Rather, they were recorded in a regulatory liability account which has been authorized by the CPUC to track lost revenues resulting from conservation. The amount recorded in the surcharge account is being used to offset future rate increases that would otherwise be necessary to recover lost revenue due to drought conservation efforts. San Jose Water Company suspended its allocation and drought surcharge program provided for in Schedule 14.1, Water Shortage Contingency Plan with Staged Mandatory Reductions and Drought Surcharges on February 1, 2017. As of June 30, 2017, San Jose Water Company has no balance remaining in the drought surcharge account to offset future rate increases related to drought conservation efforts. The remaining balance at June 30, 2017 related to drought surcharges collected outside of the California regulated entity. On June 13, 2017, the SCVWD adopted Resolution 17-43 to encourage making conservation a way of life in California through recommendations on watering schedules and a call for customers to achieve a 20% reduction in water use as compared to 2013. In addition to the SCVWD’s resolution, the mandatory water use restrictions set forth by the State Water Resources Control Board’s Emergency Regulations remain in effect. San Jose Water Company is continually working to maintain compliance with the various drought rules and regulations and is also working with local governments as well as the SCVWD to communicate consistent messages to the public about use restrictions and related matters associated with the recent drought.

Effective March 31, 2014, San Jose Water Company received approval from the CPUC to institute a Mandatory Conservation Revenue Adjustment Memorandum Account. This account was subsequently replaced with a Water Conservation Memorandum Account (“WCMA”). The WCMA allows San Jose Water Company to track lost revenue associated with reduced sales due to drought related water conservation and the associated calls for water use reduction from the SCVWD. San Jose Water Company records the lost revenue captured in the WCMA regulatory accounts once the revenue recognition requirements of FASB ASU Topic 980 - “Regulated Operations,” subtopic 605-25 are met. For further discussion, please see Note 8 and Note 9.

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 2014 Employee Stock Purchase Plan (“ESPP”). For the three months ended June 30, 2017 and 2016, 981 and 2,470 anti-dilutive restricted common stock units were excluded from the dilutive earnings per share calculation, respectively. For the six months ended June 30, 2017 and 2016, 2,987 and 4,087 anti-dilutive restricted common stock units were excluded from the dilutive earnings per share calculation, respectively.

A portion of depreciation expense is allocated to administrative and general expense. For the three months ended June 30, 2017 and 2016, the amounts allocated to administrative and general expense were $579 and $422, respectively. For the six months ended June 30, 2017 and 2016, the amounts allocated to administrative and general expense were $1,106 and $834, respectively.


Note 2.	Equity Plans

SJW Group accounts for share-based compensation based on the grant date fair value of the 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 the estimated fair value for all share-based payment awards. See Note 1 for the effect of the SJW Group’s adoption of ASU 2016-09, “Improvements to Employee Share-Based Payment Accounting” in the first quarter of 2017.

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 shares, or other share-based awards. As of June 30, 2017, the remaining number of shares available under the Incentive Plan was 957,121, and an additional 214,333 shares were issuable under outstanding restricted stock units and deferred restricted stock units. In addition, shares are issued to employees under the company’s ESPP.

SJW GROUP AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

June 30, 2017

(in thousands, except share and per share data)

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, 2017 and 2016.



	Three months ended June 30,			Six months ended June 30,
	2017		2016	2017		2016
Adjustments to additional paid-in capital and common stock for:
Compensation costs charged to income:
ESPP	$	—	—	$	100	79
Restricted stock and deferred restricted stock	458		379	944		773
Total compensation costs charged to income	$	458	379	$	1,044	852
Excess tax benefits realized from stock issuance:
Restricted stock and deferred restricted stock	$	—	94	$	—	202
Total excess tax benefits realized from stock issuance	$	—	94	$	—	202
Proceeds from ESPP and similar instruments:
ESPP	$	—	—	$	570	451
Total proceeds from the ESPP and similar instruments	$	—	—	$	570	451

Stock, Restricted Stock and Deferred Restricted Stock

On January 3, 2017, service based restricted stock units covering an aggregate of 8,564 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 $52.59 per unit which was based on the award grant date fair value is being recognized over the service period beginning in 2017.

On January 24, 2017, 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 10,744 that will vest based on the actual attainment of specified performance goals measured for the 2017 calendar year and continued service through December 31, 2017. Of such performance-based restricted stock units, units covering 6,639 shares of common stock were granted to a key officer which will only vest on the actual attainment of a specified performance goal, the number of shares issuable under this award is either 0% or 100%. The number of shares issuable under the remaining 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 share-based compensation expense of $50.24 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, 2017, management believes that the performance goals will be met.

On January 24, 2017, 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 2,737 that will vest based on the actual attainment of specified performance goals for the 2019 calendar year and continued service through December 31, 2019. 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 share-based compensation expense of $48.56 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, 2017, management believes that the performance goals will be met.

On April 26, 2017, restricted stock units covering an aggregate of 9,240 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. Share-based compensation expense of $51.13 per unit, which is based on the award grant date fair value, is being recognized over the service period beginning in 2017.

As of June 30, 2017, the total unrecognized compensation costs related to restricted and deferred restricted stock plans was $1,658. This cost is expected to be recognized over a remaining weighted average period of 0.88 years.

SJW GROUP AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

June 30, 2017

(in thousands, except share and per share data)

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 have been reserved for issuance under the ESPP.

After considering estimated employee terminations or withdrawals from the plan before the purchase date, SJW Group’s recorded expenses were $54 and $117 for the three and six months ended June 30, 2017, respectively, and $47 and $87 for the three and six months ended June 30, 2016, respectively, related to the ESPP.

The total unrecognized compensation costs related to the semi-annual offering period that ends July 31, 2017 for the ESPP is approximately $20. This cost is expected to be recognized during the third quarter of 2017.


Note 3.	Real Estate Investments

The major components of real estate investments as of June 30, 2017 and December 31, 2016 are as follows:



	June 30, 2017		December 31, 2016
Land	$	13,262	15,218
Buildings and improvements	42,964		46,826
Intangibles	—		149
Subtotal	56,226		62,193
Less: accumulated depreciation and amortization	10,545		11,734
Total	$	45,681	50,459

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 $1,156. 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.

SJW GROUP AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

June 30, 2017

(in thousands, except share and per share data)


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. 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, 2017 and 2016 are as follows:



	Three months ended June 30,					Six months ended June 30,
	2017			2016		2017			2016
Service cost	$	1,288		1,249		$	2,614		2,490
Interest cost	1,920			1,858		3,823			3,736
Other cost	1,165			1,091		2,203			2,201
Expected return on assets	(2,053		)	(1,893	)	(4,119		)	(3,788	)
	$	2,320		2,305		$	4,521		4,639

The following tables summarize the fair values of plan assets by major categories as of June 30, 2017 and December 31, 2016:



		Fair Value Measurements at June 30, 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		$	5,812	$	5,812	$	—	$	—
Actively Managed (a):
All Cap Equity	Russell 3000 Value	6,001		5,965		36		—
U.S. Large Cap Equity	Russell 1000, Russell 1000 Growth, Russell 1000 Value	45,599		45,599		—		—
U.S. Mid Cap Equity	Russell Mid Cap, Russell Mid Cap Growth, Russell Mid Cap Value	8,748		8,748		—		—
U.S. Small Cap Equity	Russell 2000, Russell 2000 Growth, Russell 2000 Value	7,697		7,697		—		—
Non-U.S. Large Cap Equity	MSCI EAFE	5,503		5,503		—		—
REIT	NAREIT - Equity REIT’S	5,859		—		5,859		—
Fixed Income (b)	(b)	41,692		—		41,692		—
Total		$	126,911	$	79,324	$	47,587	$	—

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.

SJW GROUP AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

June 30, 2017

(in thousands, except share and per share data)



		Fair Value Measurements at December 31, 2016
				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		$	10,050	$	10,050	$	—	$	—
Actively Managed (a):
All Cap Equity	Russell 3000 Value	5,290		5,266		24		—
U.S. Large Cap Equity	Russell 1000, Russell 1000 Growth, Russell 1000 Value	39,534		39,534		—		—
U.S. Mid Cap Equity	Russell Mid Cap, Russell Mid Cap Growth, Russell Mid Cap Value	7,021		7,021		—		—
U.S. Small Cap Equity	Russell 2000, Russell 2000 Growth, Russell 2000 Value	6,357		6,357		—		—
Non-U.S. Large Cap Equity	MSCI EAFE	4,832		4,832		—		—
REIT	NAREIT - Equity REIT’S	5,663		—		5,663		—
Fixed Income (b)	(b)	40,514		—		40,514		—
Total		$	119,261	$	73,060	$	46,201	$	—


(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.

In 2017, San Jose Water Company expects to make required and discretionary cash contributions of up to $7,500 to the pension plans and Social Welfare Plan. For the three and six months ended June 30, 2017, $1,280 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 (See Note 3), and (iv) Texas Water Alliance Limited, a non-tariffed water utility operation which has 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, 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.

SJW GROUP AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

June 30, 2017

(in thousands, except share and per share data)

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, 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	68,317		1,223	942		804		68,317	2,969	71,286
Operating income (loss)	30,519		687	385		(804	)	30,519	268	30,787
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 Three Months Ended June 30, 2016
	Water Utility Services			Real Estate Services	All Other*		SJW Group
	Regulated		Non-tariffed	Non-tariffed	Non-tariffed		Regulated	Non-tariffed	Total
Operating revenue	$	83,746	1,542	1,656	—		83,746	3,198	86,944
Operating expense	54,667		1,038	1,021	418		54,667	2,477	57,144
Operating income (loss)	29,079		504	635	(418	)	29,079	721	29,800
Net income (loss) before noncontrolling interest	15,023		214	178	1,360		15,023	1,752	16,775
Depreciation and amortization	10,676		118	393	—		10,676	511	11,187
Senior note, mortgage and other interest expense	4,655		—	240	574		4,655	814	5,469
Income tax expense (benefit) in net income	9,705		168	107	931		9,705	1,206	10,911
Assets	$	1,314,565	18,976	64,867	929		1,314,565	84,772	1,399,337



	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	123,938		2,054	1,890	1,616		123,938	5,560	129,498
Operating income (loss)	41,116		1,120	1,000	(1,616	)	41,116	504	41,620
Net income (loss) before noncontrolling interest	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

SJW GROUP AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

June 30, 2017

(in thousands, except share and per share data)



	For Six Months Ended June 30, 2016
	Water Utility Services			Real Estate Services	All Other*		SJW Group
	Regulated		Non-tariffed	Non-tariffed	Non-tariffed		Regulated	Non-tariffed	Total
Operating revenue	$	141,887	2,746	3,423	—		141,887	6,169	148,056
Operating expense	102,788		1,920	2,053	914		102,788	4,887	107,675
Operating income (loss)	39,099		826	1,370	(914	)	39,099	1,282	40,381
Net income (loss) before noncontrolling interest	18,594		319	431	809		18,594	1,559	20,153
Depreciation and amortization	21,349		234	787	—		21,349	1,021	22,370
Senior note, mortgage and other interest expense	9,281		—	490	1,133		9,281	1,623	10,904
Income tax expense (benefit) in net income	11,977		274	248	534		11,977	1,056	13,033
Assets	$	1,314,565	18,976	64,867	929		1,314,565	84,772	1,399,337

* The “All Other” category includes the accounts of SJW Group on a stand-alone basis.


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, 2017, 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, 2017 approximates their carrying value as reported on the condensed consolidated balance sheets. The fair value of such financial instruments are determined using the income approach based on the present value of estimated future cash flows. There have been no changes in valuation technique during the three and six months ended June 30, 2017. 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 $525,609 and $502,446 as of June 30, 2017 and December 31, 2016, 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 $430,926 and $433,460 as of June 30, 2017 and December 31, 2016, respectively. The fair value of long-term debt would be categorized as Level 2 in the fair value hierarchy.

As of June 30, 2017 and December 31, 2016, the fair value of the company’s investment in California Water Service Group was $3,680 and $3,390, respectively, and would be categorized as Level 1 of the fair value hierarchy.


Note 8.	Regulatory Rate Filings

On January 6, 2017, San Jose Water Company filed Advice Letter No. 501 with the CPUC requesting authorization to implement a sales reconciliation mechanism to better conform to water forecasts authorized in the last general rate case to recorded consumption for the period of October 2015 through September 2016. The CPUC has ordered all Class A and B water utilities that have a five percent or greater divergence between authorized and actual sales during declared drought years to request a sales reconciliation mechanism to better conform to water forecasts authorized in the last general rate case to recorded consumption. On May 3, 2017, the CPUC rejected the filing citing the end of a drought and the improved California water supply conditions. On May 10, 2017, San Jose Water Company formally requested the CPUC’s review of the rejection. The request for review is still pending before the CPUC.

SJW GROUP AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

June 30, 2017

(in thousands, except share and per share data)

As required by the CPUC, on April 3, 2017 San Jose Water Company filed an application with the CPUC requesting authority to increase its authorized Cost of Capital for the period from January 1, 2018 through December 31, 2020. If approved by the CPUC, San Jose Water Company’s annual revenues would increase by approximately $7,550 or about 2.1% in 2018.

On May 2, 2017, San Jose Water Company filed Advice Letter No. 508 with the CPUC to reinstate surcharges to recover the remaining $996 balance from the 2014 Mandatory Conservation Revenue Adjustment Memorandum Account (“MCRAMA”) and to recover the remaining $2,233 balance from the 2015 WCMA. The under-collections will be recovered via surcharges of $0.08 per CCF and $0.1441 per CCF on the existing quantity rate for the 2014 MCRAMA and the 2015 WCMA, respectively. This request was approved on June 1, 2017. San Jose Water Company anticipates collection of the remaining amounts in less than 12 months.

On May 26, 2017, San Jose Water Company filed Advice Letter No. 509 with the CPUC requesting authorization to increase revenues by $12,407, or approximately 3.46%. The increase is intended to offset the increases to purchased potable water, ground water production, and purchased recycled water charges that will be implemented by San Jose Water Company’s water wholesaler effective July 1, 2017. This request was approved on June 26, 2017.

On June 6, 2017, San Jose Water Company filed Advice Letter No. 510 with the CPUC requesting authorization to issue a surcredit totaling $1,794 to refund service charge rate changes as a result of a change in billing practice effective January 1, 2017. The refund period covers prorated service charge rate changes that occurred from January 1, 2014, through December 31, 2016. The request is still pending before the CPUC.


Note 9.	Balancing and Memorandum Account Recovery Procedures

San Jose Water Company 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, WCMA, drought surcharges, Monterey Water Revenue Adjustment Mechanism, and other approved activities or as directed by the CPUC. 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. 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 $4,989 and $7,049 due to lost revenues accumulated in the 2017 WCMA account for the three and six months ended June 30, 2017, respectively. These regulatory assets were offset by a regulatory liability in the amount of $3,988 and $6,048 for three and six months ended June 30, 2017, respectively, created by Tariff Rule 14.1 drought surcharges collected as allowed for in Advice Letter 473A. As of June 30, 2017, there was no longer a balance of drought surcharges collected to fully offset the 2017 WCMA account. The remaining balance at June 30, 2017 related to drought surcharges collected outside of the California regulated entity. Of the $4,989 and $7,049 recognized in the 2017 WCMA account for the three and six months ended June 30, 2017, respectively, $1,277 was not covered by drought surcharges and was recognized as revenue for the three and six months ended June 30, 2017 less a $276 reserve for the estimated amount that may not be collected within the 24-month period defined in the guidance. These amounts have been recorded in the 2017 WCMA row shown in the table below.

On June 1, 2017, the CPUC approved Advice Letter No. 508 to reinstate surcharges to recover the remaining balances from the 2014 WCMA and 2015 WCMA accounts which are expected to be recovered in full within a 12-month period. For the three and six months ended June 30, 2017, in accordance with ASC Topic 980-605-25 San Jose Water Company recognized in revenue the reserve balances of $978 and $2,219 for the 2014 WCMA and 2015 WCMA, respectively, which are recorded in their respective rows in the table below.

SJW GROUP AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

June 30, 2017

(in thousands, except share and per share data)



	Three months ended June 30, 2017											Three months ended June 30, 2016
	Beginning Balance			Revenue Increase (Reduction)		Refunds (Collections)		Surcharge Offset		Ending Balance		Beginning Balance			Revenue Increase (Reduction)		Refunds (Collections)		Surcharge Offset		Ending Balance

Memorandum accounts:
2014 WCMA*	$	—		978		(70	)	—		908		$	2,427		(152	)	(712	)	—		1,563
2015 WCMA*	398			2,183		(486	)	—		2,095		5,352			(77	)	(528	)	—		4,747
2016 WCMA	—			45		—		(45	)	—		—			3,747		—		(3,747	)	—
2017 WCMA*	—			4,989		—		(3,988	)	1,001		—			—		—		—		—
All others	3,680			658		212		—		4,550		1,110			551		—		—		1,661
Total memorandum accounts	4,078			8,853		(344	)	(4,033	)	8,554		8,889			4,069		(1,240	)	(3,747	)	7,971

Balancing accounts, net assets:
Water supply costs	5,684			1,358		272		—		7,314		2,436			257		(52	)	—		2,641
Drought surcharges	(5,054		)	—		60		4,033		(961	)	(512		)	—		(4,951	)	3,747		(1,716	)
Pension	(2,539		)	273		(641	)	—		(2,907	)	(427		)	280		(373	)	—		(520	)
2012 General Rate Case true-up	18,424			—		(2,659	)	—		15,765		30,572			—		(2,832	)	—		27,740
2015 General Rate Case true-up	4,097			—		(1,686	)	—		2,411		—			8,767		—		—		8,767
All others	(623		)	(232	)	(305	)	—		(1,160	)	1,225			(97	)	(27	)	—		1,101
Total balancing accounts	$	19,989		1,399		(4,959	)	4,033		20,462		$	33,294		9,207		(8,235	)	3,747		38,013

Total	$	24,067		10,252		(5,303	)	—		29,016		$	42,183		13,276		(9,475	)	—		45,984

SJW GROUP AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

June 30, 2017

(in thousands, except share and per share data)



	Six months ended June 30, 2017											Six months ended June 30, 2016
	Beginning Balance			Revenue Increase (Reduction)		Refunds (Collections)		Surcharge Offset		Ending Balance		Beginning Balance			Revenue Increase (Reduction)		Refunds (Collections)		Surcharge Offset		Ending Balance

Memorandum accounts:
2014 WCMA*	$	—		1,089		(181	)	—		908		$	2,944		(152	)	(1,229	)	—		1,563
2015 WCMA*	1,589			2,113		(1,607	)	—		2,095		5,372			(97	)	(528	)	—		4,747
2016 WCMA	—			1,452		—		(1,452	)	—		—			6,761		—		(6,761	)	—
2017 WCMA*	—			7,049		—		(6,048	)	1,001		—			—		—		—		—
All others	2,768			1,329		453		—		4,550		594			1,068		(1	)	—		1,661
Total memorandum accounts	4,357			13,032		(1,335	)	(7,500	)	8,554		8,910			7,580		(1,758	)	(6,761	)	7,971

Balancing accounts, net assets:
Water supply costs	5,190			1,555		569		—		7,314		2,771			(56	)	(74	)	—		2,641
Drought surcharges	(7,688		)	—		(773	)	7,500		(961	)	(359		)	—		(8,118	)	6,761		(1,716	)
Pension	(2,009		)	446		(1,344	)	—		(2,907	)	(552		)	560		(528	)	—		(520	)
2012 General Rate Case true-up	20,682			—		(4,917	)	—		15,765		33,070			—		(5,330	)	—		27,740
2015 General Rate Case true-up	5,528			—		(3,117	)	—		2,411		—			8,767		—		—		8,767
All others	(151		)	(446	)	(639	)	76		(1,160	)	1,366			(227	)	(38	)	—		1,101
Total balancing accounts	$	21,552		1,555		(10,221	)	7,576		20,462		$	36,296		9,044		(14,088	)	6,761		38,013

Total	$	25,909		14,587		(11,556	)	76		29,016		$	45,206		16,624		(15,846	)	—		45,984

* As of June 30, 2017, the reserve balance for the 2017 WCMA was $276 which has been netted from the three and six months ended June 30, 2017 balance above. As of June 30, 2016, the reserve balance for the 2014 WCMA and 2015 WCMA was $1,431 and $2,420, respectively, which has been netted from the three and six months ended June 30, 2016 balances above.

As of June 30, 2017, 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 $3,635. 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, 2017

(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, 2017 and December 31, 2016:



Description	June 30, 2017		December 31, 2016
Regulatory assets:
Income tax temporary differences, net	$	10,139	10,139
Postretirement pensions and other medical benefits	109,795		109,795
Balancing and memorandum accounts, net	29,016		25,909
Other, net	5,854		5,930
Total regulatory assets, net in Consolidated Balance Sheets	$	154,804	151,773
Less: current regulatory asset, net	7,672		16,064
Total regulatory assets, net, less current portion	$	147,132	135,709


Note 11.	Texas Water Alliance Limited

On February 22, 2016, SJW Group entered into a purchase and sale agreement (“PSA”) with the Guadalupe-Blanco River Authority (“GBRA”), pursuant to which SJW Group agreed to sell all of its equity interests in its wholly owned subsidiary Texas Water Alliance Limited to GBRA for $31,000 in cash. Pursuant to the PSA, upon closing of the transaction, GBRA will hold back $3,000 (the “Holdback Amount”) in the payment of the total purchase price. Pursuant to an amendment agreement entered into by SJW Group and GBRA on June 22, 2017, (i) if closing occurs, GBRA will pay the Holdback Amount to SJW Group on June 30, 2021 subject to reductions under certain circumstances, and (ii) the $3,000 previously deposited in escrow by GBRA was distributed to SJW Group on June 23, 2017 and is classified as a non-refundable deposit on the consolidated balance sheets as of June 30, 2017 (the “Deposit Amount”). If closing occurs, the Deposit Amount will be credited against the $31,000 purchase price. The PSA is subject to the completion of financing by GBRA to fund the purchase price and other customary closing conditions. There is no assurance that the closing conditions will be satisfied in a timely manner, or at all.


Note 12.	Legal Proceedings

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.


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, 2016.

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 filed with the Securities and Exchange Commission (the “SEC”) under the item 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 subsidiaries: San Jose Water Company, SJW Land Company, SJWTX, Inc., and Texas Water Alliance Limited.

San Jose Water Company, a wholly owned subsidiary of SJW Group, 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., a wholly owned subsidiary of SJW Group, doing business as Canyon Lake Water Service Company (“CLWSC”), is a public utility in the business of providing water service to approximately 13,000 connections that serve approximately 41,000 people. CLWSC’s service area comprises more than 244 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, a wholly owned subsidiary of SJW Group, owned the following real properties during the year-to-date period ended June 30, 2017:



				% for Six months ended June 30, 2017 of SJW Land Company
Description	Location	Acreage	Square Footage	Revenue		Expense
Commercial building	San Jose, California	2	28,000	6	%	9	%
Warehouse building	Knoxville, Tennessee	30	361,500	40	%	36	%
Commercial building	Knoxville, Tennessee	15	135,000	54	%	55	%
Undeveloped land and parking lot	Knoxville, Tennessee	10	N/A	N/A		N/A
Undeveloped land	San Jose, California	5	N/A	N/A		N/A

SJW Land Company owns a 70% limited partnership interest in 444 West Santa Clara Street, L.P. One of the California properties was owned by such partnership. The limited partnership has been determined to be a variable interest entity within the scope of FASB ASC Topic 810 – “Consolidation” with SJW Land Company as the primary beneficiary, and as a result, it has been consolidated with SJW Land Company. See Note 3 of Notes to Unaudited Condensed Consolidated Financial Statements for a discussion of the sale of 444 West Santa Clara’s, L.P.’s property as well as a San Jose, California undeveloped land property on April 6, 2017.

Texas Water Alliance Limited (“TWA”), a wholly owned subsidiary of SJW Group, has acquired permits and leases necessary to develop a water supply project in Texas. TWA obtained groundwater production and transportation permits to meet the future water needs in the CLWSC’s service area and to the central Texas hill country communities and utilities adjacent to the area. On February 22, 2016, we entered into an agreement with Guadalupe Blanco River Authority (“GBRA”), pursuant to which SJW Group agreed to sell all of its equity interest in TWA to GBRA for $31,000. The agreement is subject to the completion of financing by GBRA to fund the purchase price and other customary closing conditions. On June 22, 2017, SJW Group and GBRA entered into an amendment and SJW Group received $3,000 previously deposited in escrow by GBRA as a non-refundable deposit. See Note 11 of the Notes to Unaudited Condensed Consolidated Financial Statements for a discussion on the pending sale of SJW Group’s equity interest in TWA. There is no assurance that all of the closing conditions will be satisfied in a timely manner, or at all.

Business Strategy for Water Utility Services:

SJW Group focuses its business initiatives in three strategic areas:


(1)	Regional regulated water utility operations;


(2)	Regional non-tariffed water utility related services provided in accordance with the guidelines established by the CPUC in California and the PUCT in Texas; and


(3)	Out-of-region water and utility related services.

As part of our pursuit of the above three strategic areas, the company considers from time to time opportunities to acquire businesses and assets. However, SJW Group cannot be certain it will be successful in identifying and consummating any strategic business acquisitions relating to such opportunities. In addition, the execution of our business strategy will expose us to different risks than those associated with the current utility operations. We expect to incur costs in connection with the execution of this strategy and any integration of an acquired business could involve significant costs, the assumption of certain known and unknown liabilities related to the acquired assets, the diversion of management’s time and resources, the potential for a negative impact on SJW Group’s financial position and operating results, entering markets in which SJW Group has no or limited direct prior experience and the potential loss of key employees of any acquired company. Any future acquisition we decide to undertake may also impact our ability to finance our business, affect our compliance with regulatory requirements, and impose additional burdens on our operations. Any businesses we acquire may not achieve sales, customer growth and projected profitability that would justify the investment. Any difficulties we encounter in the integration process, including the integration of controls necessary for internal control and financial reporting, could interfere with our operations, reduce our operating margins and adversely affect our internal controls. SJW Group cannot be certain that any transaction will be successful or that it will not materially harm its operating results or financial condition.

Real Estate Services:

SJW Group’s real estate investment activity is conducted through SJW Land Company. As noted above, SJW Land Company owns undeveloped land and operates commercial buildings in Tennessee. SJW Land Company also owns a limited partnership

interest in 444 West Santa Clara Street, L.P. The partnership owned a commercial building in San Jose, California. On April 6, 2017, 444 West Santa Clara Street, L.P. sold all of its interests in the commercial building and land the partnership owns and operates. In addition, SJW Land Company sold the undeveloped land located in San Jose, California on April 6, 2017. See Note 3 of Notes to Unaudited Condensed Consolidated Financial Statements for the discussion of the sale transactions.

SJW Land Company manages its income producing and other properties until such time a determination is made to reinvest proceeds from the sale of such properties. SJW Land Company’s real estate investments diversify SJW Group’s asset base.

Critical Accounting Policies:

The discussion and analysis of our financial condition and results of operations is based on the accounting policies used and disclosed in our 2016 consolidated financial statements and accompanying notes that were prepared in accordance with accounting principles generally accepted in the United States of America and included as part of our annual report on Form 10-K for the year ended December 31, 2016 that was filed with the SEC on February 28, 2017.

Our critical accounting policies are described in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our annual report on Form 10-K for the year ended December 31, 2016. There have been no changes in our critical accounting policies. Our significant accounting policies are described in our notes to the 2016 consolidated financial statements included in our annual report on Form 10-K for the year ended December 31, 2016.

Impact of Recent Accounting Pronouncements:

In May 2014, the 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. When it becomes effective, the new standard will replace most existing revenue recognition guidance in generally accepted accounting principles. Since the issuance of ASU 2014-09, the FASB also has issued additional ASUs that clarify implementation guidance regarding principal versus agent considerations, licensing, and identifying performance obligations, as well as adding certain additional practical expedients. The new standard can be applied retrospectively to each prior period presented or on a modified retrospective basis with a cumulative effect adjustment to retained earnings on the date of adoption. SJW Group has not made a final decision on the transition method, but currently anticipates using the modified retrospective method. The company does not anticipate the ASU will significantly impact the recognition of metered revenue, however consistent with others in the industry the company is still evaluating the impact the ASU will have on its revenue classification and disclosures related to its alternative revenue programs and treatment of contributions in aid of construction. Concurrently, the company will implement ASU 2017-10, “Identifying the Customer in a Service Concession Arrangement.” SJW Group will adopt these standards on January 1, 2018, their required effective date.

In January 2016, the FASB issued ASU 2016-01, “Financial Instruments - Overall” which will significantly change 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 update is effective for SJW Group beginning in the first quarter of the fiscal year ending December 31, 2018. Management is currently evaluating the effect that the new standard will have on its consolidated financial statements and related disclosures.

In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842),” which supersedes the lease requirements in “Leases (Topic 840).” This ASU requires a lessee to recognize a right-of-use asset and a lease payment liability for most leases in the Consolidated Statement of Financial Position. ASU 2016-02 also makes some changes to lessor accounting and aligns with the new revenue recognition guidance. This ASU will be effective for the company in the first quarter of 2019 and earlier adoption is permitted. Management is currently evaluating the effect that the new standard will have on its consolidated financial statements and related disclosures.

In March 2016, the FASB issued ASU 2016-09, “Improvements to Employee Share-Based Payment Accounting.” This ASU affects entities that issue share-based payment awards to their employees. ASU 2016-09 identifies areas for simplification involving several aspects of accounting for share-based payment transactions, including income tax consequences, classification of awards as either equity or liabilities, classifications on the statement of cash flows and forfeiture rate calculations. SJW Group adopted this standard as of the first quarter of 2017. ASU 2016-09 requires recognition of excess tax benefits and deficiencies in the income statement, which resulted in the recognition of $500 in income tax benefit for the three months ended March 31, 2017. Prior to adoption, these amounts were recognized as additional paid-in capital. SJW Group did not have any unrecognized excess tax benefits to reclassify upon adoption of this standard. The ASU also requires excess tax benefits and deficiencies to be prospectively excluded from assumed future proceeds in the calculation of diluted shares when calculating diluted earnings per shares using the treasury stock method. The effect of this change on diluted earnings per share

was immaterial. In addition, excess income tax benefits from share-based compensation are now classified as cash flows from operating activities on the consolidated statements of cash flows, prospectively. Further, ASU 2016-09 requires, on a retrospective basis, that employee taxes paid for withheld shares be classified as cash flows from financing activities rather than cash flows from operating activities. As such, the consolidated statements of cash flows for SJW Group for the periods presented have been reclassified to reflect this change. This change resulted in an increase to cash flows from operating activities and a decrease to cash flows from financing activities of $815 and $486 for the three months ended March 31, 2017 and 2016, respectively. SJW Group has elected to account for actual forfeitures as they occur upon adoption of the new guidance. Management determined that the cumulative effect adjustment required under the new guidance was immaterial and therefore SJW Group did not record an adjustment.

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. The update will become effective for SJW Group on January 1, 2018, with early adoption permitted as of January 1, 2017. The standard requires modified retrospective transition with a cumulative catch-up adjustment to opening retained earnings in the period of adoption. Management is currently evaluating the effect that the new standard will have on its consolidated financial statements and related disclosures.

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 only allows the service cost component to be eligible for asset capitalization. Employers will present the other components of net periodic benefit costs separately from the line item(s) that includes the service cost and outside of any subtotal of operating income, if one is presented. This ASU will be effective for the company in the first quarter of 2018 and earlier adoption is permitted. Management is currently evaluating the effect that the new standard will have on its consolidated financial statements and related disclosures.

Results of Operations:

See Note 1 of Notes to Unaudited Condensed Consolidated Financial Statements for a discussion of the California drought and political and regulatory activities that have occurred in response to the recent drought conditions.

Overview

SJW Group’s consolidated net income for the three months ended June 30, 2017 was $18,688, an increase of $1,913, or approximately 11%, from $16,775 for the same period in 2016. SJW Group’s consolidated net income for the six months ended June 30, 2017 was $22,359, an increase of $2,206, or approximately 11%, from $20,153 for the same period in 2016. The increase in net income for the three months ended June 30, 2017 was primarily due to an increase in operating revenue as a result of higher rates, recognition of $4,677 in revenue from the Water Conservation Memorandum Account (“WCMA”), and an increase in usage, offset by a decrease of $8,767 in true-up revenue from the 2015 General Rate Case decision recorded in prior year and higher water production expenses. The increase in net income for the six months ended June 30, 2017 was primarily due to an increase in operating revenue as a result of higher rates, recognition of $5,191 in revenue from the WCMA which includes $1,371 from 2016 for the revision to new customer classifications and an increase in usage, offset by a decrease of $8,767 in true-up revenue from the 2015 General Rate Case decision recorded in the prior year and higher water production expenses. In addition, for both the three and six months ended June 30, 2017 a gain on the sale of the limited partnership properties and undeveloped land in San Jose, California generated a pre-tax increase of $6,903, net of the noncontrolling interest’s gain of $1,896, which was offset by the pre-tax gain on sale of California Water Service Group stock of $3,197 recorded in the same periods during the prior year.

Operating Revenue



	Operating Revenue by Segment
	Three months ended June 30,			Six months ended June 30,
	2017		2016	2017		2016
Water Utility Services	$	100,746	85,288	$	168,228	144,633
Real Estate Services	1,327		1,656	2,890		3,423
	$	102,073	86,944	$	171,118	148,056

The change in consolidated operating revenues was due to the following factors:



	Three months ended June 30, 2017 vs. 2016					Six months ended June 30, 2017 vs. 2016
	Increase/(decrease)					Increase/(decrease)
Water Utility Services:
Consumption changes	$	3,182		4	%	$	1,593		1	%
Increase in customers	344			—	%	463			—	%
Rate increases	14,955			17	%	23,574			16	%
Balancing and memorandum accounts:
WCMA	4,677			5	%	5,191			4	%
2015 General Rate Case true-up	(8,767		)	(10	)%	(8,767		)	(6	)%
All other	1,066			1	%	1,541			1	%
Real Estate Services	(328		)	—	%	(533		)	—	%
	$	15,129		17	%	$	23,062		16	%

Operating Expense



	Operating Expense by Segment
	Three months ended June 30,			Six months ended June 30,
	2017		2016	2017		2016
Water Utility Services	$	69,540	55,705	$	125,992