H2O AMERICA 10-Q

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 condensed 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, 2021. 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. Actual results may differ materially from those currently anticipated and expressed in such forward-looking statements as a result of a number of factors. For more information about such forward-looking statements, including some of the factors that may affect our actual results, please see our disclosures under “Forward-Looking Statements,” and elsewhere in this Form 10-Q, including Part II, Item 1A under “Risk Factors.” General: SJW Group is a holding company with five wholly-owned subsidiaries: San Jose Water Company (“SJWC”), SJWNE LLC, SJWTX, Inc., SJW Land Company, and SJWTX Holdings, Inc. SJWC is a public utility in the business of providing water service to approximately 232,000 connections that serve a population of approximately one million people in an area comprising approximately 139 square miles in the metropolitan San Jose, California area. The principal business of SJWC consists of the production, purchase, storage, purification, distribution, wholesale, and retail sale of water. SJWC provides water service to customers in portions of the cities of San Jose and Cupertino and in the cities of Campbell, Monte Sereno, and Saratoga and the Town of Los Gatos, and adjacent unincorporated territories, all in the County of Santa Clara in the State of California. SJWC distributes water to customers in accordance with accepted water utility methods which include pumping from storage and gravity feed from high elevation reservoirs. SJWC 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. SJWC 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 serve 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. SJWC also has approximately 234 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 SJWC’s various watershed properties. SJWNE LLC is the holding company for Connecticut Water Service, Inc. (“CTWS”). CTWS, headquartered in Connecticut, serves as a holding company for water utility companies providing water service to approximately 141,000 connections that serve a population of approximately 460,000 people in 81 municipalities throughout Connecticut and Maine and more than 3,000 wastewater connections in Southbury, Connecticut. The subsidiaries held by CTWS that provide utility water services are The Connecticut Water Company (“Connecticut Water”) and The Maine Water Company (“Maine Water”). The remaining two CTWS subsidiaries are Chester Realty, Inc., a real estate company in Connecticut, and New England Water Utility Services, Inc. (“NEWUS”), which provides contract water and sewer operations and other water related services. The properties of CTWS’s subsidiaries consist of land, easements, rights (including water rights), buildings, reservoirs, standpipes, dams, wells, supply lines, water treatment plants, pumping plants, transmission and distribution mains and other facilities and equipment used for the collection, purification, storage and distribution of water throughout Connecticut and Maine. In certain cases, Connecticut Water and Maine Water are or may be a party to limited contractual arrangements for the provision of water supply from neighboring utilities. SJWTX, Inc., doing business as Canyon Lake Water Service Company (“CLWSC”), is a public utility in the business of providing water service to approximately 25,000 connections that serve approximately 76,000 people and approximately 900 wastewater connections. CLWSC’s service area comprises more than 267 square miles in Bandera, Blanco, Comal, Hays, Kendall, Medina and Travis County in the growing region between San Antonio and Austin, Texas. SJWTX, Inc. holds a 25% equity interest in Acequia Water Supply Corporation. Acequia 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. SJWTX, Inc is undergoing a corporate reorganization to separate regulated operations from non-tariffed 19 activities. In November 2021, SJWTX Holdings, Inc. (“SJWTX Holdings”) and Texas Water Operation Services LLC (“TWOS”) were formed for the purpose of effecting a corporate reorganization of our water services organization in Texas. TWOS was created for non-tariffed operations and is wholly-owned by SJWTX Holdings. SJWTX Holdings is a wholly-owned subsidiary of SJW Group, incorporated to hold the investments in SJWTX, Inc. and TWOS. In addition, SJWTX Holdings intends to create a new subsidiary to hold future wholesale water supply assets prior to the end of 2022. SJW Land Company and Chester Realty, Inc. own undeveloped land and operate commercial buildings in Tennessee, California and Connecticut. SJW Land Company and Chester Realty, Inc. owned the following real properties during the nine months ended September 30, 2022: % for Nine months ended September 30, 2022 of Real Estate Services Description Location Acreage Square Footage Revenue Expense Warehouse building Knoxville, Tennessee 30 361,500 52 % 43 % Commercial building Knoxville, Tennessee 15 135,000 47 % 56 % Undeveloped land and parking lot Knoxville, Tennessee 10 N/A N/A N/A Undeveloped land San Jose, California 101 N/A N/A N/A Commercial building Clinton, CT 22 9,000 1 % 1 % Commercial building Guilford, CT 1 1,300 — % — % 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, the Public Utilities Regulatory Authority (“PURA”) in Connecticut, the Public Utilities Commission of Texas (“PUCT”) in Texas, and the Maine Public Utilities Commission (“MPUC”) in Maine; and (3) Out-of-region water and utility related services. As part of our pursuit of the above three strategic areas, we consider from time to time opportunities to acquire businesses and assets. However, we cannot be certain we will be successful in identifying and consummating any strategic business combination or 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 our financial position and operating results, entering markets in which we have no or limited direct prior experience and the potential loss of key employees of any acquired company. Any strategic combination or 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 operating results or our financial condition. Real Estate Services: SJW Group’s real estate investment activity is conducted through SJW Land Company and Chester Realty, Inc. As noted above, SJW Land Company owns undeveloped land and operates commercial buildings in Tennessee. Chester Realty, Inc. owns and operates land and commercial buildings in Connecticut. SJW Land Company and Chester Realty, Inc. manage income producing and other properties until such time a determination is made to reinvest proceeds from the sale of such properties. 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 2021 consolidated financial statements and accompanying notes that were prepared in accordance with 20 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, 2021, that was filed with the Securities and Exchange Commission on February 28, 2022. 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, 2021. Our significant accounting policies are described in our notes to the 2021 Consolidated Financial Statements included in our annual report on Form 10-K for the year ended December 31, 2021. There have been no changes to our critical or significant accounting policies during the three months ended September 30, 2022. Results of Operations: 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. Overview SJW Group’s consolidated net income for the three months ended September 30, 2022, was $25,034, an increase of $5,966, or approximately 31%, from $19,068 for the same period in 2021. Consolidated net income for the three months ended September 30, 2022 includes a one-time impact of $355 related to SJWC’s Order Instituting Investigation settlement expenses. SJW Group’s consolidated net income for the nine months ended September 30, 2022, was $40,329, a decrease of $2,130, or approximately 5%, from $42,459 for the same period in 2021. Consolidated net income in 2022 includes a gain on the sale of nonutility property of $5,072, offset by the one-time impacts of $2,200 related to depreciation on certain Cupertino concession assets and $1,196 related to SJWC’s Order Instituting Investigation settlement expenses and certain true-ups of deferred taxes and acquisition related tax expenses. Operating Revenue Operating Revenue by Segment Three months ended September 30, Nine months ended September 30, 2022 2021 2022 2021 Water Utility Services $ 174,507 165,520 $ 445,128 429,882 Real Estate Services 1,474 1,403 4,196 4,067 $ 175,981 166,923 $ 449,324 433,949 The change in consolidated operating revenues was due to the following factors: Three months ended September 30, 2022 vs. 2021 Nine months ended September 30, 2022 vs. 2021 Increase/(decrease) Increase/(decrease) Water Utility Services: Consumption changes (including unbilled utility revenue) $ (4,256) (3) % $ (9,085) (2) % Increase in customers 842 1 % 3,723 1 % Rate increases 9,485 6 % 22,172 5 % Texas winter storm customer credits 838 — % 838 — % Balancing and memorandum accounts Monterey Water Revenue Adjustment Mechanism (“MWRAM”) 1,019 1 % 2,047 1 % Water Conservation Memorandum Account (“WCMA”) 3,868 2 % 2,768 1 % Other 184 — % 1,011 — % Other regulatory mechanisms (2,967) (2) % (8,466) (2) % Other (26) — % 239 — % Real Estate Services 71 — % 128 — % $ 9,058 5 % $ 15,375 4 % 21 Operating Expense Operating Expense by Segment Three months ended September 30, Nine months ended September 30, 2022 2021 2022 2021 Water Utility Services $ 136,831 132,071 $ 363,488 349,432 Real Estate Services 975 956 2,799 2,718 All Other 573 122 2,444 2,307 $ 138,379 133,149 $ 368,731 354,457 The change in consolidated operating expense was due to the following factors: Three months ended September 30, 2022 vs. 2021 Nine months ended September 30, 2022 vs. 2021 Increase/(decrease) Increase/(decrease) Water production expenses: Change in surface water use $ (1,794) (1) % $ (5,445) (2) % Change in usage and new customers (6,044) (5) % (13,267) (4) % Purchased water and groundwater extraction charge, energy price change and other production expenses, net 9,250 7 % 20,381 6 % Balancing and memorandum accounts cost recovery 87 — % 1,257 1 % Total water production expenses 1,499 1 % 2,926 1 % Administrative and general 756 1 % 4,387 1 % Balance and memorandum account cost recovery 440 — % 2,055 1 % Maintenance 696 1 % 1,430 — % Property taxes and other non-income taxes 229 — % 1,453 1 % Depreciation and amortization 1,692 1 % 7,555 2 % Gain on sale of nonutility properties (82) — % (5,532) (2) % $ 5,230 4 % $ 14,274 4 % Sources of Water Supply SJWC’s water supply consists of imported water purchased from the Santa Clara Valley Water District (“Valley Water”) under the terms of a master contract with Valley Water expiring in 2051, groundwater from wells, surface water from watershed run-off and diversion, and reclaimed water. Surface water is the least expensive source of water. Changes and variations in quantities from each of these sources affect the overall mix of the water supply, thereby affecting water supply cost. In addition, the water rate for purchased water and the groundwater extraction charge may be increased by Valley Water at any time. If an increase occurs, then SJWC would file an advice letter with the CPUC seeking authorization to increase customer rates to offset the cost increase. Such water supply cost and rate changes are expected to be mitigated in the future as a result of the water cost balancing account adopted in SJWC’s general rate case decision on October 6, 2022. We are currently experiencing a severe drought in California that is expected to have a significant impact on the sources of our water supply. On October 1, 2022, Valley Water’s 10 reservoirs were at approximately 17% of total capacity with 9,277 million gallons of water in storage, which is 40% of the twenty-year average for this date. Valley Water’s largest reservoir, Anderson, remains drained for a dam seismic retrofit project. As reported by Valley Water, there was 0.51 inches of rainfall in San Jose during the current annual rainfall season that commenced on July 1, 2022. Rainfall at SJWC’s Lake Elsman was measured at 1.68 inches during the current rainfall season compared to the five-year average of 0.04 inches. Under normal hydrologic conditions, state and federal water allocations represent approximately 40% of the Valley Water’s total annual water supply. As of October 1, 2022, Valley Water reported that allocations from the State Water Project was 5% or 1,629 million gallons and an additional allocation of human health and safety water has been secured. The U.S. Bureau of Reclamation allocation remains at public health and safety water only. Valley Water reported that its Semitropic groundwater bank reserves are at 80% of capacity or 90,747 million gallons, which can be used to perform water transfers with other state water contractors. Valley Water also reported that the managed groundwater recharge from January to September in the Santa Clara Plain was 112% of the five-year average. The groundwater level in the Santa Clara Plain is approximately 21 feet higher than September 2021. According to Valley Water, the projected total groundwater storage at the end of 2022 is expected to fall within the Normal Stage of Valley Water’s Water Shortage Contingency Plan. 22 On October 1, 2022, SJWC’s Lake Elsman contained 679 million gallons of water, of which approximately 529 million gallons can be released for treatment in water production and to maintain downstream bypass flow regulatory requirements. This Lake Elsman volume represents 82% of the five-year average. Local surface water is a less costly source of water than groundwater or purchased water and its availability significantly impacts SJWC’s results of operations. Typically, SJWC will utilize surface water and additional water from its portfolio of groundwater supplies to supplement imported water from Valley Water. Production from the Montevina Surface Water Treatment Plant through the third quarter was 1,340 million gallons, which is 88% of the five-year average. Through the third quarter of 2022, there was 43 million gallons of water production at SJWC’s smaller Saratoga Water Treatment Plant. The Saratoga Water Treatment Plant was taken out of service due to lack of run-off from Saratoga Creek and remains offline. Nonetheless, SJWC believes that its various other water supply sources will be sufficient to meet customer demand through the remainder of 2022. On June 9, 2021, Valley Water declared a water shortage emergency and asked its retailers to reduce consumption by 15% based on 2019 usage. In response to Valley Water’s declaration of drought emergency and call for conservation, SJWC filed with the CPUC to activate Stage 3 of its Rule 14.1 Water Shortage Contingency Plan. Like the most recent drought, the current restrictions center on outdoor water usage which typically accounts for half of a residential customer’s consumption. The restrictions include limits on watering days and times, use of potable water for washing structures and other non-porous surfaces except to protect public health and safety, and no outdoor watering during and up to 48 hours after measurable rainfall. Connecticut Water’s water sources vary among the individual systems, but overall approximately 80% of the total dependable yield comes from surface water supplies and 20% from wells. In addition, Connecticut Water has water supply agreements to supplement its water supply with the South Central Connecticut Regional Water Authority and The Metropolitan District that expire 2058 and 2053, respectively. CLWSC’s water supply consists of groundwater from wells and purchased treated and untreated raw water from local water agencies. CLWSC has long-term agreements with the GBRA, which expire in 2037, 2040, 2044 and 2050. The agreements, which are take-or-pay contracts, provide CLWSC with an aggregate of 7,650 acre-feet of water per year from Canyon Lake at prices that may be adjusted periodically by GBRA. CLWSC also has raw water supply agreements with the Lower Colorado River Authority (“LCRA”) and West Travis Public Utility Agency (“WTPUA”) expiring in 2059 and 2046, respectively, to provide for 350 acre-feet of water per year from Lake Austin and the Colorado River, respectively, at prices that may be adjusted periodically by the agencies. Production wells located in a Comal Trinity Groundwater Conservation District, a regulated portion of the Trinity aquifer, are charged a groundwater pump tax based upon usage. Water sources at Maine Water vary among the individual systems, but overall approximately 90% of the total dependable yield comes from surface water supplies and 10% from wells. Maine Water has a water supply agreement with the Kennebec Water District expiring in 2040. The following table presents the change in sources of water supply, in million gallons, for Water Utility Services: Three months ended September 30, Increase/ (decrease) % of Total Change Nine months ended September 30, Increase/ (decrease) % of Total Change 2022 2021 2022 2021 Purchased water 7,098 5,703 1,395 9 % 16,136 15,601 535 1 % Groundwater 4,870 6,283 (1,413) (9) % 13,790 16,850 (3,060) (8) % Surface water 2,866 3,113 (247) (2) % 8,153 6,947 1,206 3 % Reclaimed water 322 341 (19) — % 694 669 25 — % 15,156 15,440 (284) (2) % 38,773 40,067 (1,294) (4) % The changes in the source of supply mix were consistent with the changes in the water production expenses. SJWC’s unaccounted-for water on a 12-month-to-date basis for September 30, 2022, and 2021 approximated 8.6% and 6.9%, respectively, as a percentage of total production. The unaccounted-for water estimate is based on the results of past experience and the impact of flows through the system, partially offset by SJWC’s main replacements and lost water reduction programs. CTWS’s unaccounted-for water on a 12-month-to-date basis for September 30, 2022, and 2021 was approximately 14.2% and 14.6%, respectively, as a percentage of total production. The unaccounted-for water estimate is based on the results of past experience and the impact of flows through CTWS’s systems, unadjusted for any required system flushing, partially offset by Water Infrastructure Conservation Adjustment and Water Infrastructure Surcharge main replacement programs and lost water reduction initiatives. Water Production Expenses The change in water production expenses for the three and nine months ended September 30, 2022, compared to the same period in 2021, was primarily attributable to increases in average per unit costs for purchased water, groundwater extraction, 23 energy charges and other production expenses, offset by a decrease in customer usage and an increase in available surface water for SJWC. Effective July 1, 2022, Valley Water increased the unit price of purchased water by approximately 14% and the groundwater extraction charge by approximately 15%. Other Operating Expenses Operating expenses, excluding water production expenses, increased $3,731 for the three months ended September 30, 2022, compared to the same period in 2021. The increase was primarily attributable to increases of $1,692 in depreciation and amortization due to increases in utility plant, $1,196 in administrative and general expenses primarily due to increases in labor, and an increase of $696 in maintenance expenses. Operating expenses, excluding water production expenses, increased $11,348 for the nine months ended September 30, 2022, compared to the same period in 2021. The increase was primarily attributable to increases of $7,555 in depreciation and amortization due to increases in utility plant and a true up related to Cupertino assets to adjust the useful lives over the concession term, an increase of $6,442 in administrative and general expenses primarily due to increases in labor and changes in cost recovery balancing and memorandum accounts, an increase of $1,453 in taxes other than income due to utility plant increases and an increase of $1,430 in maintenance expenses, partially offset by the gain on sale of vacant land located in California and nonutility property in Texas. Other (Expense) Income For the three months ended September 30, 2022 , compared to the same period in 2021, the change in other (expense) income was primarily due to an increase in interest on the line of credit resulting from an increase in borrowings and higher short term borrowing rates, partially offset by a reduction in pension non-service cost. For the nine months ended September 30, 2022 , compared to the same period in 2021, the change in other (expense) income was primarily due to the $3,000 pre-tax gain on sale from the release of a holdback amount by GBRA for the sale of TWA in prior year and a decrease in the return from retirement plan assets, partially offset by a reduction in pension non-service cost. Provision for Income Taxes For the three and nine months ended September 30, 2022, compared to the same period in 2021, income tax expense decreased $2,526 and $1,501, respectively. The decrease in income tax expense for the three and nine months ended September 30, 2022 was primarily due to discrete tax items and, for the nine months ended September 30, 2022, lower income. The effective consolidated income tax rates were 1% and 13% for the three months ended September 30, 2022, and 2021, respectively, and 8% and 11% for the nine months ended September 30, 2022, and 2021, respectively. The lower effective rate for the three and nine months ended September 30, 2022, was primarily due to a tax accounting method change at CTWS related to the non-network assets repairs deduction. On August 16, 2022, the Inflation Reduction Act of 2022 (the “IRA”) was signed into law. SJW Group has considered the income tax implications of the IRA in its estimated tax provision and does not believe it will materially impact the company’s year-end tax rate. Regulation and Rates Almost all of the operating revenue of SJW Group results from the sale of water at rates authorized by the subsidiaries’ respective state utilities commissions. The state utilities commissions set rates that are intended to provide revenue sufficient to recover operating expenses and the opportunity to achieve a specified return on common equity. The timing of rate decisions could have an impact on the results of operations. Please also see Note 2 of “Notes to Condensed Consolidated Financial Statements.” California Regulatory Affairs SJWC filed General Rate Case Application No. 21-01-003 (“2022 GRC”) on January 4, 2021, requesting authority for an increase of revenue of $51,585 or 13.35% in 2022, $16,932 or 3.88% in 2023, and $19,195 or 4.24% in 2024. The application included requests to recover $18,499 from balancing and memorandum accounts, authorization for a $435,000 capital budget, further alignment between actual and authorized usage, and a shift to greater revenue collection in the service charge. Due to the delayed CPUC decision, SJWC was approved for interim rates effective January 1, 2022 via Advice Letter No. 573 on December 30, 2021. The authorization of interim rates allows SJWC to retroactively apply the final decision to January 1, 2022. The interim rates approved were set to equal the present rates in effect to avoid customer confusion and short-term bill changes. SJWC and the Public Advocates Office filed an amended settlement agreement resolving all issues in the proceeding on February 4, 2022, for the CPUC’s consideration and adoption. The settlement provides a revenue increase of $54,131 over the three-year period with an increase of $25,074 in 2022 and a recovery of $18,174 from balancing and memorandum accounts. The settlement recognizes the need for continued investments in the water system to deliver safe and reliable water 24 service, providing authorization of a three-year $350,000 capital budget. Additionally, it further aligns authorized and actual consumption, particularly for business customers, addresses the water supply mix variability, and provides greater revenue recovery in the fixed charge. The CPUC approved the settlement on October 6, 2022 and issued Decision No. 22-10-005 (“2022 GRC Decision”) on October 11, 2022. SJWC will be filing advice letters to implement new rates and to recover interim revenue and balancing and memorandum accounts in accordance with the 2022 GRC Decision. On May 3, 2021, SJWC filed Application No. 21-05-004 requesting authority to adjust its cost of capital for the period from January 1, 2022 through December 31, 2024. The request seeks a revenue increase of $6,418 or 1.61% in 2022. The application also proposes a rate of return of 8.11%, an increase from the current rate of 7.64%, a decrease in the average cost of debt rate from 6.20% to 5.48%, and a return of equity of 10.30%, an increase from the current rate of 8.90%. In addition, the request seeks to adjust SJWC’s currently authorized capital structure of approximately 47% debt and 53% equity to approximately 45% debt and 55% equity. If approved, new rates are expected to be effective in the fourth quarter of 2022. On December 6, 2019, SJWC filed Application No. 19-12-002 to deploy Advanced Metering Infrastructure (“AMI”) throughout its service area. On August 5, 2021, an all-party settlement agreement was submitted to the CPUC for adoption that would authorize the deployment of AMI outside of the capital budget requested in the 2022 GRC. A final decision approving the settlement agreement was issued on June 10, 2022. SJWC filed Advice Letter No. 577 on May 24, 2022 to increase revenue requirement by $24,331 or 5.9% to offset the increases to purchased potable water charges, the groundwater extraction fee, and purchased recycled water charges from its water wholesalers effective July 1, 2022. Advice Letter No. 577 was approved on June 30, 2022. On October 12, 2022, SJWC filed Advice Letter No. 581 to recover $18,174 in balancing and memorandum accounts in accordance to the 2022 GRC Decision. This filing is pending before the CPUC. On October 12, 2022, SJWC filed Advice Letter No. 582 to refund $19,921 accumulated in its WCMA and its Water Conservation Expense Memorandum Account (“WCEMA”) through August 31, 2022. This refund amount will offset the $18,174 requested in Advice Letter No. 581 resulting in a net refund to customers of $1,747. Netting the two balances against each other allows for immediate recovery of the balancing and memorandum accounts and results in less confusion on customer bills. The approvals of both Advice Letter No. 581 and 582 are conditioned on this approach and are pending before the CPUC. On October 13, 2022, SJWC filed Advice Letter No. 583 to increase revenue requirement by $25,074 or 6% and implement new water rates in accordance with the 2022 GRC Decision. This filing is anticipated to become effective November 1, 2022, pending the CPUC’s approval. Connecticut Regulatory Affairs On October 26, 2021, Connecticut Water filed for a Water Infrastructure Conservation Adjustment (“WICA”) increase of approximately $21,746 in completed projects. Many of the projects were those that were not considered by PURA in the rate case because of the deadline in the proceeding for pro forma capital additions. On December 22, 2021, PURA approved a WICA surcharge of 2.44% to be added to bills of all Connecticut Water customers, including those of the former The Avon Water Company and The Heritage Village Water Company, effective January 1, 2022 which is expected to generate approximately $2,581 in additional revenue. On February 14, 2022 Connecticut Water filed its 2021 WICA reconciliation with PURA. The reconciliation, approved by PURA on March 16, 2022 and effective for 12 months beginning April 1, 2022, replaced the expiring 2020 reconciliation surcharge of 0.07% with a credit of 0.02%. As a result, the net WICA surcharge, effective April 1, 2022 was 2.35%. On February 28, 2022 Connecticut Water filed its 2021 Water Rate Adjustment mechanism (“WRA”). The mechanism reconciles 2021 revenues as authorized in the Company’s most recent rate cases. The 2021 WRA, as approved by PURA on March 30, 2022 and effective for 12 months beginning on April 1, 2022 imposed a 2.85% surcharge on customer bills to collect the 2021 revenue shortfall. On April 26, 2022, Connecticut Water filed for a WICA increase of $9,779 in completed projects. PURA approved the Company’s application on June 22, 2022. The cumulative WICA charge as of July 1, 2022 is 3.26%, collecting $3,448 on an annual basis. On June 17, 2022, Connecticut Water submitted an application to PURA for the approval to issue unsecured notes in the amount of $25,000. The notes carry an interest rate of 4.71% and the closing is expected to occur on December 15, 2022. A decision from PURA approving the application was received on August 10, 2022. Texas Regulatory Affairs CLWSC filed its 2022 Water Pass Through Charge (“WPC”) true-up report for its Canyon Lake water system on January 31, 2022 with the PUCT under Docket No. 53173. The PUCT modified the WPC formula which resulted in a new usage rate 25 increasing from $0.70 to $0.90 dollars per thousand gallons. The new usage rate was effective March 1, 2022. The true-up report was approved by the PUCT on May 10, 2022 and CLWSC received approval of the new tariff on May 24, 2022. CLWSC filed its 2022 WPC true-up report for its Kendall West system on June 29, 2022 with the PUCT under Docket No. 53751. CLWSC requested an increase from $2.39 to $3.69 per thousand gallons for the WPC. The WPC increased the rate from $2.39 to $2.56 per thousand gallons on October 1, 2022. Maine Regulatory Affairs The rates approved in the Biddeford Saco division by the April 5, 2022 stipulated agreement, which authorized a rate increase of $6,313, or 72.5% went into effect on July 1, 2022. The Saco River Drinking Water Resource Center began supplying the water distribution system on June 16, 2022. On February 28, 2022, Maine Water filed requests for general rate increases in the Camden-Rockland, Freeport, Millinocket and Oakland Divisions. The four filings collectively request $532 in new revenue and seek to reset the WISC in all four divisions. The four cases, while docketed separately, are proceeding through the adjudication process together. Decisions by the Commission in these filings are expected in the fourth quarter of 2022. Liquidity: Cash Flow from Operating Activities During the nine months ended September 30, 2022, SJW Group generated cash flows from operations of approximately $129,300, compared to $100,300 for the same period in 2021. Cash flow from operations is primarily generated by net income from revenue producing activities, adjusted for non-cash expenses for depreciation and amortization, deferred income taxes, stock-based compensation, allowance for equity funds used during construction, gains or losses on the sale of assets, and changes in working capital items. Cash flow from operations increased by approximately $29,000. This increase was the result of a combination of the following factors: (1) an increase of $34,200 in regulatory assets primarily due to the recognition of balancing and memorandum accounts, and (2) general working capital and net income, adjusted for non-cash items, increased by $5,200, offset by (3) payments of amounts previously invoiced and accrued including accrued production costs, decreased by $4,500, (4) increase of payments for postretirement benefits of $3,000, and (5) a decrease of $2,900 from higher accounts receivable balances. As of September 30, 2022, Water Utility Services’ write-offs for uncollectible accounts represented less than 1% of its total revenue, unchanged from September 30, 2021. As of February 1, 2022, the remaining state executive order suspending water service disconnections due to non-payment by customers expired in California. There is no guarantee that the respective state regulators will not reinstate such orders. Management believes that the collection rate for its accounts receivables will gradually return to pre-pandemic levels now that service disconnections are allowable once again to mitigate payment delinquencies. On February 3, 2022, SJWC received $9,757 through the State of California Water and Wastewater Arrearages Payment Program to relieve outstanding payment delinquencies for customers accounts greater that 60-days past due as of June 30, 2021. Bill credits were applied to customer accounts that remained outstanding and the excess of $3,272 was returned to the State of California. The financial impact of certain remaining past due accounts are being recorded for future recovery through the rate-making process. There is no guarantee that such recovery will be approved by the respective state regulatory utility commissions. Cash Flow from Investing Activities During the nine months ended September 30, 2022, SJW Group used cash flows from investing activities of approximately $181,500, compared to $182,900 for the same period in 2021. SJW Group used approximately: (1) $160,500 of cash for company-funded capital expenditures, (2) $17,800 for developer-funded capital expenditures, and (3) $2,400 for utility plant retirements. Water Utility Services’ budgeted capital expenditures for 2022, exclusive of capital expenditures financed by customer contributions and advances, are anticipated to be approximately $223,000. As of September 30, 2022, approximately $160,500 or 72% of the $223,000 has been invested. Water Utility Services’ capital expenditures are incurred in connection with normal upgrading and expansion of existing facilities and to comply with environmental regulations. Over the next five years, Water Utility Services expects to incur approximately $1,300,000 in capital expenditures, which includes replacement of pipes and mains, and maintaining water systems. A significant portion of this amount is subject to future respective state regulatory utility commissions’ approval. Capital expenditures have the effect of increasing utility plant rate base on which Water Utility Services earns a return. Water Utility Services actual capital expenditures may vary from their projections due to changes in the expected demand for services, weather patterns, actions by governmental agencies, and general economic conditions. Total additions to utility plant normally 26 exceed Company-financed additions as a result of new facilities construction funded with advances from developers and contributions in aid of construction. The Water Utility Services’ distribution systems were constructed during the period from the early 1900’s through today. Expenditure levels for renewal and modernization will occur as the components reach the end of their useful lives. In most cases, replacement cost will significantly exceed the original installation cost of the retired assets due to increases in the costs of goods and services and increased regulation. Cash Flow from Financing Activities Net cash provided by financing activities for the nine months ended September 30, 2022, decreased by approximately $36,400 from the same period in the prior year, primarily as a result of (1) a decrease in net proceeds of $157,100 from lower borrowings on long-term debt and increase of payments to long-term debt, (2) a decrease in net proceeds from our common stock equity offering in prior year of $63,700, (3) an increase of dividends paid to stockholders of $2,700, offset by (4) an increase in net borrowings and repayments on our lines of credit of $189,200. Sources of Capital: SJW Group’s ability to finance future construction programs and sustain dividend payments depends on its ability to maintain or increase internally generated funds and attract external financing. The level of future earnings and the related cash flow from operations is dependent, in large part, upon the timing and outcome of regulatory proceedings. Short-term Financing Agreements SJW Group and its subsidiaries have unsecured line of credit agreements where borrowings are used for long-term capital expenditure financing, working capital, and general corporate purposes. A summary of the line of credit agreements as of September 30, 2022, are as follows: Maturity Date Line Limit Amounts Outstanding Unused Portion Syndicated credit agreement: August 2, 2027 SJW Group $ 50,000 — 50,000 SJWC 140,000 95,000 45,000 CTWS 90,000 56,000 34,000 SJWTX, Inc. 20,000 1,500 18,500 Total syndicated credit agreement 300,000 152,500 147,500 CTWS credit agreement December 14, 2023 10,000 6,670 3,330 CTWS credit agreement May 15, 2025 40,000 40,000 — $ 350,000 199,170 150,830 On August 2, 2022, SJW Group, SJWC, SJWTX, Inc., and CTWS entered into a $300,000 credit agreement (the “Credit Agreement”) with JPMorgan Chase Bank, N.A., as Administrative Agent (“JP Morgan”), Wells Fargo Bank, National Association, as Documentation Agent, and a syndicate of banks. Proceeds of borrowings under the Credit Agreement will be used for refinancing existing debt, working capital, and general corporate purposes. The Credit Agreement has a maturity date of August 2, 2027. Under the terms of the Credit Agreement, each of SJW Group, SJWC, SJWTX, Inc., and CTWS is a borrower with several and not joint liability. Each borrower has an initial borrowing entitlement, or sublimit, which can be periodically adjusted from time to time as set forth in the Credit Agreement. The initial sublimit of each borrower is as presented in the table above. Borrowings under the Credit Agreement bear interest at either the Alternative Base Rate (as defined in the Credit Agreement and hereinafter referred to as “ABR”) or the Adjusted Term Secured Overnight Financing Rate (as defined in the Credit Agreement and hereinafter referred to as “SOFR”). ABR borrowings (which are borrowings bearing interest at a rate determined by reference to ABR) will bear interest at a rate per annum equal to ABR plus the applicable rate. SOFR borrowings (which are borrowings bearing interest at a rate determined by reference to SOFR) will bear interest at a rate per annum equal to SOFR plus the applicable rate. The applicable rate and pricing is variable depending on credit ratings of the borrower. 27 The Credit Agreement contains customary representations, warranties and events of default, as well as certain restrictive covenants customary for facilities of this type, including restrictions on indebtedness, liens, asset sales, and fundamental changes. The Credit Agreement also includes a financial covenant that requires each of the borrowers to maintain its funded debt to capitalization ratio at or below 70%. This Credit Agreement replaces the existing $140,000 credit agreement, dated April 23, 2021, between SJWC and JP Morgan and the existing $5,000 credit agreement, dated April 23, 2021, between SJWTX and JP Morgan, with SJW Group as guarantor, both of which were terminated upon entering into the Credit Agreement and were set to mature on December 31, 2023. In addition, on August 2, 2022, CTWS and Citizens Bank, National Association, entered into a fourth modification to the amended and restated revolving credit facility, dated December 18, 2019, as amended, pursuant to which the credit commitment was reduced from $75,000 to $10,000. During the nine months ended September 30, 2022, cost of borrowing on the lines of credit averaged 2.79% compared to 1.34% in the same period in 2021. All of SJW Group’s and subsidiaries lines of credit contain customary representations, warranties and events of default, as well as certain restrictive covenants customary for facilities of this type, including restrictions on indebtedness, liens, acquisitions and investments, restricted payments, asset sales, and fundamental changes. All of the lines of credit also include certain customary financial covenants such as a funded debt to capitalization ratio and a minimum interest coverage ratio. As of September 30, 2022, SJW Group and its subsidiaries were in compliance with all covenants on their lines of credit. Long-term Financing Agreements SJW Group and its subsidiaries long-term debt activities are for purposes of refinancing short-term borrowings, long-term capital expenditure financing and working capital, and refinancing of maturing long-term debt. On April 6, 2022, Maine Water entered into a credit agreement with a commercial bank, pursuant to an existing master loan agreement under which the commercial bank issued Maine Water a promissory note on the same date with an aggregate principal amount of $15,000 at a fixed interest rate of 4.54%, due May 31, 2042. The notes are unsecured obligations of Maine Water. Interest is payable quarterly in arrears on the 20th day of January, April, July and October of each year. The promissory note contains customary representations and warranties. Under the promissory note, Maine Water is required to comply with certain customary affirmative and negative covenants for as long as the notes are outstanding. The notes are also subject to customary events of default, the occurrence of which may result in all of the notes then outstanding becoming immediately due and payable. Proceeds from the borrowing were received on May 13, 2022. On June 28, 2022, Connecticut Water entered into a note purchase agreement with certain affiliates of New York Life Insurance Company, pursuant to which Connecticut Water sold an aggregate principal amount of $25,000 of its 4.71% Senior Notes, Series 2022, due 2052. The closing of the note purchase agreement is expected to occur on December 15, 2022, and is subject to customary closing conditions. The Series 2022 Notes are unsecured obligations of Connecticut Water. Interest is payable semi-annually in arrears on June 15th and December 15th of each year. The note purchase agreement contains customary representations and warranties. Connecticut Water has agreed to customary affirmative and negative covenants for as long as the Series 2022 Notes are outstanding. The Series 2022 Notes are also subject to customary events of default, the occurrence of which may result in all of the Series 2022 Notes then outstanding becoming immediately due and payable. On July 14, 2022, SJWC entered into a note purchase agreement with certain affiliates of New York Life Insurance, Metropolitan Life Insurance, Northwestern Mutual Life Insurance, and John Hancock Life Insurance (collectively the “Purchasers”), pursuant to which the company will sell an aggregate principal amount of $70,000 of its 4.85% Senior Notes, Series P (“Series P Notes”) to the Purchasers. The Series P Notes are unsecured obligations of SJWC and are due on February 1, 2053. Interest is payable semi-annually in arrears on February 1st and August 1st of each year. The note purchase agreement contains customary affirmative and negative covenants for as long as the Series P Notes are outstanding. The Series P Notes are also subject to customary events of default. The closing is expected to occur in January 2023 upon satisfaction of customary closing conditions. The debt and credit agreements of SJW Group and its subsidiaries contain various financial and other covenants. Non-compliance with these covenants could result in accelerated due dates and termination of the agreements. In addition, the credit agreements contain customary representations and warranties and are subject to customary events of default, which may result in the outstanding debt becoming immediately due and payable. As of September 30, 2022, SJW Group and its subsidiaries were in compliance with all covenants related to its long-term debt agreements. Equity Financing Arrangements On November 17, 2021, SJW Group entered into an equity distribution agreement (the “Equity Distribution Agreement”) with J.P. Morgan Securities LLC, Janney Montgomery Scott LLC, RBC Capital Markets, LLC and Wells Fargo Securities, LLC (each a “Sales Agent” and, collectively, the “Sales Agents”), pursuant to which the company may offer and sell shares of its 28 common stock, $0.001 par value per share (the “Shares”), from time to time in “at-the-market” offerings, having an aggregate gross sales price of up to $100,000. Pursuant to the Equity Distribution Agreement, the Shares may be offered and sold through the Sales Agents in transactions that are deemed to be “at-the-market” offerings as defined in Rule 415 under the Securities Act of 1933, as amended, including sales by means of ordinary brokers’ transactions on the New York Stock Exchange or otherwise at market prices prevailing at the time of sale, at prices related to the prevailing market prices or at negotiated prices, in block transactions, or as otherwise agreed upon by the company and the Sales Agents. Proceeds from the sale of the shares under the Equity Distribution Agreement can be used in the financing of acquisitions, infrastructure improvements and other capital expenditures, repayment of debt or other corporate obligations, and working capital over the term of the Equity Distribution Agreement as such needs arise. For the three and nine months ended September 30, 2022, SJW Group issued and sold a total of 47,608 shares of common stock with a weighted average price of $66.26 per share and received approximately $3,107 in net proceeds under the Equity Distribution Agreement. Since the inception of the Equity Distribution Agreement, SJW Group has issued and sold 402,723 shares of common stock with a weighted average price of $69.91 for a total net proceeds of $27,360 and has a remaining $71,845 under the Equity Distribution Agreement to issue into shares. Credit Rating The condition of the capital and credit markets or the strength of financial institutions could impact SJW Group’s ability to draw on its lines of credit, issue long-term debt, sell its equity or earn interest income. In addition, government policies, the state of the credit markets and other factors could result in increased interest rates, which would increase SJW Group’s cost of capital. While our ability to obtain financing will continue to be a risk, we believe that based on our 2022 and 2021 activities, we will have access to the external funding sources necessary to implement our on-going capital investment programs in the future. The current Standard & Poor’s Rating Service assigned company rating for SJW Group is an A-, with a stable outlook, for SJWC is an A, with a stable outlook, CTWS is an A- with a stable outlook, and Connecticut Water is an A- with a stable outlook.