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 September 30, 2005 - -------------------------------------------------------------------------------- Commission file number 1-8966 - -------------------------------------------------------------------------------- SJW Corp. - -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) California 77-0066628 - -------------------------------------------------------------------------------- (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 374 West Santa Clara Street, San Jose, CA 95113 - -------------------------------------------------------------------------------- (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 changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate by check mark whether the registrant is an accelerated filer. Yes X No --- --- APPLICABLE ONLY TO CORPORATE ISSUERS: Common shares outstanding as of November 1, 2005 are 9,135,441. 1
<TABLE> <CAPTION> PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS -------------------- SJW CORP. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (UNAUDITED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) THREE MONTHS NINE MONTHS ENDED SEPTEMBER 30 ENDED SEPTEMBER 30 2005 2004 2005 2004 -------- ------- --------- --------- <S> <C> <C> <C> <C> OPERATING REVENUE $ 58,469 52,297 $ 136,575 128,969 OPERATING EXPENSES Operation: Purchased water 15,512 14,396 34,431 32,572 Power 1,872 2,108 3,392 4,519 Pump taxes 7,285 8,266 13,145 17,289 Administrative and general 5,311 4,462 14,899 13,256 Other 3,701 3,108 10,308 9,644 Maintenance 2,252 2,216 6,633 6,503 Property taxes and other nonincome taxes 1,476 1,352 4,238 4,006 Depreciation and amortization 5,042 4,689 14,928 13,789 Income taxes 5,755 3,960 11,622 8,556 -------- ------- --------- --------- Total operating expenses 48,206 44,557 113,596 110,134 -------- ------- --------- --------- OPERATING INCOME 10,263 7,740 22,979 18,835 Interest on long-term debt (2,382) (2,372) (7,155) (7,136) Dividend income 313 311 940 932 Sale of nonutility property, net of taxes of $761 1,095 - 1,095 - Other, net (62) (149) (236) (520) -------- ------- --------- --------- NET INCOME $ 9,227 5,530 $ 17,623 12,111 ======== ======= ========= ========= Other comprehensive income: Unrealized income on investment $ 4,026 2,002 $ 3,905 2,166 Income taxes (1,651) (821) (1,601) (888) -------- ------- --------- --------- Other comprehensive income, net 2,375 1,181 2,304 1,278 -------- ------- --------- --------- COMPREHENSIVE INCOME $ 11,602 6,711 $ 19,927 13,389 ======== ======= ========= ========= EARNINGS PER SHARE Basic $ 1.01 0.61 $ 1.93 1.33 Diluted $ 1.00 0.60 $ 1.91 1.32 ======== ======= ========= ========= COMPREHENSIVE INCOME PER SHARE Basic $ 1.27 0.74 $ 2.18 1.47 Diluted $ 1.25 0.73 $ 2.16 1.46 ======== ======= ========= ========= DIVIDENDS PER SHARE $ 0.26 0.25 $ 0.79 0.76 ======== ======= ========= ========= WEIGHTED AVERAGE SHARES OUTSTANDING Basic 9,135,441 9,137,433 9,135,710 9,136,986 Diluted 9,250,491 9,198,718 9,234,724 9,193,627 See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements. 2 </TABLE>
<TABLE> <CAPTION> SJW CORP. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) (IN THOUSANDS) SEPTEMBER 30 DECEMBER 31 2005 2004 ---------- --------- ASSETS UTILITY PLANT: <S> <C> <C> Land $ 1,735 1,735 Depreciable plant and equipment 631,947 605,420 Construction in progress 10,722 4,595 Intangible assets 7,840 7,840 ----------- --------- Total utility plant 652,244 619,590 Less accumulated depreciation and amortization 204,484 189,221 ----------- --------- Net utility plant 447,760 430,369 ----------- --------- NONUTILITY PROPERTY 33,526 35,154 Less accumulated depreciation 3,590 3,167 ----------- --------- Net nonutility property 29,936 31,987 ----------- --------- CURRENT ASSETS: Cash and equivalents 11,152 10,899 Accounts receivable: Customers, net of allowances for uncollectible accounts 11,801 8,044 Other 4,907 611 Unbilled utility revenue 15,249 6,605 Long-lived assets held-for-sale 282 - Materials and supplies 635 559 Prepaid expenses 2,388 1,652 ----------- --------- Total current assets 46,414 28,370 ----------- --------- OTHER ASSETS: Investment in California Water Service Group 45,318 41,413 Unamortized debt issuance and reacquisition costs 3,174 3,300 Regulatory assets, net 7,227 8,064 Intangible pension asset 4,357 4,357 Other 3,967 4,292 ----------- --------- Total other assets 64,043 61,426 ----------- --------- $ 588,153 552,152 =========== ========= See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements. 3 </TABLE>
<TABLE> <CAPTION> SJW CORP. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) (IN THOUSANDS) SEPTEMBER 30 DECEMBER 31 2005 2004 --------- ------- CAPITALIZATION AND LIABILITIES CAPITALIZATION: <S> <C> <C> Common stock $ 9,521 9,516 Additional paid-in capital 15,094 14,306 Retained earnings 158,816 148,525 Accumulated other comprehensive income 14,648 12,344 --------- ------- Total shareholders' equity 198,079 184,691 --------- ------- Long-term debt, less current portion 145,557 143,604 --------- ------- Total capitalization 343,636 328,295 --------- ------- CURRENT LIABILITIES: Current portion of long-term debt 72 275 Accrued pump taxes and purchased water 7,017 3,856 Purchased power 1,472 848 Accounts payable 6,018 870 Accrued interest 2,203 3,619 Accrued taxes 4,658 890 Accrued payroll 1,323 1,066 Work order deposit 472 773 Other current liabilities 3,535 3,154 --------- ------- Total current liabilities 26,770 15,351 --------- ------- DEFERRED INCOME TAXES 50,810 49,507 UNAMORTIZED INVESTMENT TAX CREDITS 1,869 1,915 ADVANCES FOR CONSTRUCTION 69,578 65,251 CONTRIBUTIONS IN AID OF CONSTRUCTION 81,500 78,655 DEFERRED REVENUE 1,286 1,282 POSTRETIREMENT BENEFIT PLANS 9,936 9,359 OTHER NONCURRENT LIABILITIES 2,768 2,537 --------- ------- $ 588,153 552,152 ========= ======= See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements. 4 </TABLE>
<TABLE> <CAPTION> SJW CORP. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (IN THOUSANDS) NINE MONTHS ENDED SEPTEMBER 30 2005 2004 ---------- -------- OPERATING ACTIVITIES: <S> <C> <C> Net income $ 17,623 12,111 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 14,928 13,789 Deferred income taxes 497 4,508 Stock-based compensation 963 819 Gain on sale of nonutility property, net of taxes (1,095) - Changes in operating assets and liabilities: Accounts receivable and accrued unbilled utility revenue (16,697) (9,053) Accounts payable, purchased power and other current liabilities 6,152 6,426 Accrued pump taxes and purchased water 3,161 4,065 Accrued taxes 3,767 4,587 Accrued interest (1,416) (1,415) Accrued payroll 257 999 Work order deposits (301) (672) Prepaid expenses and materials and supplies (812) (570) Deferred revenue 4 (52) Other noncurrent assets and noncurrent liabilities 164 (1,357) Other changes, net 777 (24) ---------- -------- NET CASH PROVIDED BY OPERATING ACTIVITIES 27,972 34,161 INVESTING ACTIVITIES: Additions to utility plant (33,845) (33,175) Additions to nonutility property (322) (280) Cost to retire utility plant, net of salvage (89) (278) Proceeds from sale of nonutility property 3,414 - ---------- -------- NET CASH USED IN INVESTING ACTIVITIES (30,842) (33,733) FINANCING ACTIVITIES: Long-term borrowings 1,953 - Repayments of long-term borrowings (204) (186) Stock buyback (185) (149) Dividends paid (7,332) (6,990) Exercise of stock options 16 12 Receipts of advances and contributions in aid of construction 10,364 4,645 Refunds of advances for construction (1,489) (1,549) ---------- -------- NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 3,123 (4,217) NET CHANGE IN CASH AND EQUIVALENTS 253 (3,789) ---------- -------- CASH AND EQUIVALENTS, BEGINNING OF PERIOD 10,899 10,278 CASH AND EQUIVALENTS, END OF PERIOD $ 11,152 6,489 ======== ========= Cash paid during the period for: Interest $ 9,284 9,125 Income taxes 9,551 1,550 See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements. 5 </TABLE>
SJW CORP. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2005 Note 1. General - ---------------- In the opinion of SJW Corp., the accompanying unaudited condensed consolidated financial statements contain all adjustments, consisting only of normal recurring adjustments, necessary for the fair presentation of the results for the interim periods. The Notes to Consolidated Financial Statements in SJW Corp.'s 2004 Annual Report on Form 10-K should be read with the accompanying condensed consolidated financial statements. Water sales are seasonal in nature. The demand for water, especially by residential customers, is generally influenced by weather conditions. The timing of precipitation and climactic conditions can cause seasonal water consumption by residential 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 when cooler temperatures and increased rainfall curtail water usage and sales. Basic earnings per share and comprehensive income per share are calculated using income available to common shareholders and comprehensive income, respectively, divided by the weighted average number of shares outstanding during the period. Diluted earnings per share and comprehensive earnings per share are calculated using the weighted average number of common shares including both shares outstanding and shares potentially issuable in connection with stock options and deferred restricted common stock awards granted under SJW Corp.'s Long-Term Incentive Plan (the "Incentive Plan") and income available to common shareholders and comprehensive income. For the three months ended September 30, 2005 and 2004, the basic weighted average number of common shares was 9,135,441 and 9,137,433, respectively. For the nine months ended September 30, 2005 and 2004, the basic weighted average number of common shares was 9,135,710 and 9,136,986, respectively. For the three months ended September 30, 2005 and 2004, the diluted weighted average number of common shares outstanding was 9,250,491 and 9,198,718, respectively. For the nine months ended September 30, 2005 and 2004, the diluted weighted average number of common shares outstanding was 9,234,724 and 9,193,627, respectively. For the three and nine months ended September 30, 2005, 7,000 option share equivalents were excluded from the diluted calculation because they were anti-dilutive. 6
Note 2. Long-Term Incentive Plan - --------------------------------- Common Shares ------------- SJW Corp. has reserved 900,000 common shares for issuance under its Incentive Plan (Defined in Note 1). As of September 30, 2005, 9,031 shares have been issued pursuant to the Incentive Plan, and 186,191 shares are issuable upon the exercise of outstanding options and deferred restricted stock. The remaining shares available for issuance under the Incentive Plan are 704,778. The total compensation cost charged to income under the Incentive Plan for the three and nine months ended September 30, 2005 was $313,000 and $930,000, inclusive of dividend equivalent rights and for the three and nine months ended September 30, 2004 was $290,000 and $871,000, inclusive of dividend equivalent rights, respectively. The total benefit, including non-employee directors' converted post-retirement benefits, recorded in shareholders' equity under the Incentive Plan for the three and nine months ended September 30, 2005, was $263,000, and $963,000 and for the three and nine months ended September 30, 2004 was $250,000 and $819,000, respectively. SJW Corp. has adopted Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation", utilizing the Black-Scholes option-pricing model to compute the fair value of options at grant date as the basis for the stock-based compensation for financial reporting purposes. The weighted average assumptions utilized include: 2005 2004 2003 ---- ---- ---- Expected dividend yield 2.6% 3.3% 3.4% Expected volatility 24.3% 23.6% 27.0% Risk-free interest rate 3.67% 3.22% 2.86% Expected holding period in years 5.0 5.0 5.0 Stock Options ------------- Awards in the form of stock option agreements under the Incentive Plan allow optionees to purchase common shares at a specified price. In 2005, 21,742 and 7,000 options were issued at exercise prices of $35.26 and $55.38, respectively, in January and July to employees. The weighted average exercise price was $40.16 and the weighted-average grant-date fair value of the options was $8.17. For the nine months ended September 30, 2005 and 2004, 796 and 266 common shares were issued upon exercise of options, respectively. No exercise of options occurred in the three month period ending September 30, 2005. Shares subject to outstanding options under the Incentive Plan were 82,951 and 54,739 as of September 30, 2005 and 2004, respectively. SJW Corp. has recognized stock compensation expense for the stock options granted under the Incentive Plan of $54,000 and $152,000, respectively, for the three and nine months ended September 30, 2005, and $32,000 and $97,000, respectively, for the three and nine months ended September 30, 2004. 7
Deferred Restricted Stock Plans ------------------------------- As of September 30, 2005 and 2004, deferred restricted stock awards for 41,670 shares have been granted to a key employee of SJW Corp. SJW Corp. has recognized stock compensation expense related to these deferred restricted stock units of $129,000 and $386,000, respectively, for the three and nine months ended September 30, 2005, and $128,000 and $384,000, respectively, for the three and nine months ended September 30, 2004. As of September 30, 2005 and 2004, deferred restricted stock awards for an aggregate of 55,524 shares have been granted to non-employee Board members who elected to receive their existing and future cash pension benefits in deferred restricted stock awards under the Deferred Restricted Stock Program. As of September 30, 2005 and 2004, 4,206 and 4,029 shares, respectively, were issued pursuant to deferred restricted stock awards to a retired non-employee Board member. In accordance with SFAS No. 123, "Accounting for Stock-Based Compensation", SJW Corp. has recognized stock compensation expense of $101,000 and $303,000, respectively, for the three and nine months ended September 30, 2005 and $102,000 and $306,000, respectively, for the three and nine months ended September 30, 2004, related to deferred restricted stock awards under the Deferred Restricted Stock Program. In January 2005, deferred restricted stock awards covering 2,968 shares were issued to the non-employee Board members who elected to convert their annual retainer fee at a conversion price of $36.40 per share under the Deferred Restricted Stock Program. As of September 30, 2005 and 2004, SJW Corp. granted deferred restricted stock awards for 7,888 and 4,920 shares in lieu of cash retainer fees, respectively. SJW Corp. has recognized stock compensation expense for the three and nine months ended September 30, 2005, of $29,000 and $87,000 and for the three and nine months ended September 30, 2004, of $28,000 and $85,000, respectively, related to deferred restricted stock awards granted to non-employee Board members in connection with their annual retainers. Dividend Equivalent Rights -------------------------- Under the Incentive Plan, holders of options and deferred restricted stock awards have the right to receive dividend rights each time a dividend is paid on common shares after the grant date. Stock compensation expenses are measured and recognized on dividend equivalent rights on the date they are granted. The stock compensation expenses on stock options and deferred restricted stock awards reported in this Note 2 include the stock compensation expenses recognized on the dividend equivalent rights. As of September 30, 2005 and 2004, 6,393 and 1,908 dividend equivalent rights were converted to deferred restricted stock awards, respectively, and $147,000 and $121,000 related to dividend equivalent rights were accrued as a liability. The stock options, deferred restricted stock programs, and dividend equivalent rights are all offered through SJW Corp.'s Incentive Plan. 8
Note 3. Regulated and Nonregulated Business - -------------------------------------------- The business activities of SJW Corp. consist primarily of its subsidiary, San Jose Water Company, a public utility regulated by the California Public Utilities Commission (CPUC) that operates within a service area approved by the CPUC. Included in the total operating revenue and operating expense are the nonregulated business activities of SJW Corp. The nonregulated businesses of SJW Corp. are comprised of operating the City of Cupertino Municipal Water Systems (CMWS), parking and lease operations of several commercial buildings and properties of SJW Land Company, and the sale and rental of water conditioning and purification equipment of Crystal Choice Water Service, LLC (CCWS). The following tables represent the distribution of the regulated and nonregulated business activities for the three and nine months ended September 30, 2005 and 2004: <TABLE> <CAPTION> Three Months Ended Three Months Ended September 30 2005 September 30 2004 ----------------- ----------------- (in thousands) Non Non Regulated Regulated Total Regulated Regulated Total --------- --------- -------- --------- --------- -------- <S> <C> <C> <C> <C> <C> <C> Revenue $ 56,038 $ 2,431 $ 58,469 $ 49,884 $ 2,413 $ 52,297 Expenses 46,133 2,073 48,206 42,537 2,020 44,557 --------- --------- -------- --------- --------- -------- Operating Income $ 9,905 $ 358 $ 10,263 $ 7,347 $ 393 $ 7,740 ========= ========= ======== ========= ========= ======== Nine Months Ended Nine Months Ended September 30 2005 September 30 2004 ----------------- ----------------- (in thousands) Non Non Regulated Regulated Total Regulated Regulated Total --------- --------- -------- --------- --------- -------- Revenue $ 130,310 $ 6,265 $136,575 $ 121,998 $ 6,971 $128,969 Expenses 108,296 5,300 113,596 104,573 5,561 110,134 --------- --------- -------- --------- --------- -------- Operating Income $ 22,014 $ 965 $ 22,979 $ 17,425 $ 1,410 $ 18,835 ========= ========= ======== ========= ========= ======== </TABLE> Note 4. Nonutility Property - ---------------------------- The major components of net nonutility property as of September 30, 2005 and December 31, 2004 are as follows: 9
<TABLE> <CAPTION> September 30 2005 December 31 2004 ----------------- ---------------- (in thousands) <S> <C> <C> Land $ 7,810 $ 8,139 Buildings and improvements 25,485 26,784 Intangibles 231 231 ------- ------- Sub-total 33,526 35,154 Less: accumulated depreciation and amortization 3,590 3,167 ------- ------- Total $29,936 $31,987 ======= ======= </TABLE> Note 5. Employee Benefit Plans - ------------------------------- The components of net periodic benefit costs for SJW Corp.'s pension plan and Supplemental Executive Retirement Plan for the three and nine months ended September 30, 2005 and 2004 are as follows: <TABLE> <CAPTION> Three Months Ended Nine Months Ended September 30 September 30 2005 2004 2005 2004 ---- ---- ---- ---- (in thousands) <S> <C> <C> <C> <C> Service cost $ 513 438 $1,540 1,314 Interest cost 889 762 2,665 2,286 Other cost 341 238 1,022 714 Expected return on Assets (706) (639) (2,117) (1,917) -------- ----- ------- -------- $ 1,037 799 $3,110 2,397 ======== ===== ======= ======== </TABLE> As of September 30, 2005, SJW Corp. has contributed $1,900,000 to the pension plan and has not made a contribution to its other post-retirement plan. SJW Corp. expects to contribute an additional $1,000,000 to the pension plan and $343,000 to its other post-retirement plan in the fourth quarter of 2005. Note 6. Segment Reporting - -------------------------- SJW Corp. is a holding company with four subsidiaries: San Jose Water Company (SJWC), a water utility operation with both regulated and nonregulated businesses, SJW Land Company and its consolidated variable interest entity - 444 West Santa Clara Street, L.P., which operates parking facilities and commercial building rentals, and Crystal Choice Water Service LLC (CCWS), a business providing the sale and rental of water conditioning and purification equipment. In addition, in the third quarter of 2005, SJW Corp. formed a Texas corporation, SJWTX Water, Inc. (SJWTX Water). SJWTX Water has entered into an agreement to 10
purchase Canyon Lake Water Supply Corporation, as discussed in note 10. In accordance with Statement of Financial Accounting Standards No. 131, Disclosures about Segments of an Enterprise and Related Information, SJW Corp. 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, provided through SJW Corp.'s subsidiary, SJWC. The second segment is property management and development activity conducted by SJW Land Company. SJW Corp.'s reportable segments have been determined based on information used by the chief operating decision-maker. SJW Corp.'s chief operating decision-maker is its President and Chief Executive Officer (CEO). The CEO reviews financial information presented on a consolidated basis that is accompanied by disaggregated information about operating revenue, net income and total assets. The tables below set forth information relating to SJW Corp.'s reportable segments. Certain allocated assets, revenue and expenses have been included in the reportable segment amounts. Other business activity of SJW Corp. not included in the reportable segments is included in the "All Other" category. <TABLE> <CAPTION> THREE MONTHS ENDED SEPTEMBER 30 2005 (in thousands) SJW Land All SJW SJWC Company Other* Corp. ----------------------------------------------------------- <S> <C> <C> <C> <C> Operating revenue $ 57,387 $ 751 $ 331 $ 58,469 Operating expense 47,202 416 588 48,206 Net income 9,074 122 31 9,227 Depreciation and amortization 4,865 157 20 5,042 Interest expense 2,382 - - 2,382 Income tax expense 5,796 77 (118) 5,755 Assets $500,869 $39,247 $ 48,037 $588,153 THREE MONTHS ENDED SEPTEMBER 30 2004 (in thousands) SJW Land All SJW SJWC Company Other* Corp. ----------------------------------------------------------- Operating revenue $ 51,086 $ 786 $ 425 $ 52,297 Operating expense 43,504 435 618 44,557 Net income 5,335 99 96 5,530 Depreciation and amortization 4,513 156 20 4,689 Interest expense 2,372 - - 2,372 Income tax expense 3,858 90 12 3,960 Assets $475,147 $32,785 $ 34,964 $542,896 </TABLE> 11
<TABLE> <CAPTION> NINE MONTHS ENDED SEPTEMBER 30 2005 (in thousands) SJW Land All SJW SJWC Company Other* Corp. ----------------------------------------------------------- <S> <C> <C> <C> <C> Operating revenue $133,280 $ 2,315 $ 980 $136,575 Operating expense 110,566 1,363 1,667 113,596 Net income 17,048 399 176 17,623 Depreciation and amortization 14,400 469 59 14,928 Interest expense 7,155 - - 7,155 Income tax expense 11,568 343 (289) 11,622 Assets $500,869 $39,247 $48,037 $588,153 NINE MONTHS ENDED SEPTEMBER 30 2004 (in thousands) SJW Land All SJW SJWC Company Other* Corp. ----------------------------------------------------------- Operating revenue $124,926 $ 2,712 $ 1,331 $128,969 Operating expense 106,889 1,412 1,833 110,134 Net income 11,212 530 369 12,111 Depreciation and amortization 13,271 459 59 13,789 Interest expense 7,136 - 7,136 Income tax expense 8,234 433 (111) 8,556 Assets $475,147 $32,785 $34,964 $542,896 </TABLE> *The "All Other" category includes CCWS, and without regard to its subsidiaries, SJW Corp. The assets of SJW Corp. include the investment in California Water Service Group. Please refer to Notes to Consolidated Financial Statements in SJW Corp.'s 2004 Annual Report on Form 10-K. Note 7. Stock Repurchase - ------------------------- On April 29, 2004, SJW Corp.'s Board of Directors authorized a stock repurchase program to repurchase up to 100,000 shares of its outstanding common stock over the next 36 months. In 2004, SJW Corp. repurchased a total of 4,295 shares of its outstanding common stock at the prevailing price in the open market at an aggregate cost of $144,000. No shares were repurchased in the first three months of 2005. During the second quarter of 2005, SJW Corp. repurchased a total of 4,736 shares of its outstanding common stock at the prevailing price in the open market at an aggregate cost of $185,000. No shares were repurchased in the third quarter of 2005. All repurchased shares have been cancelled and are considered authorized and unissued. 12
Note 8. Long-term Liabilities - ------------------------------ SJW Corp.'s contractual obligations and commitments include senior notes, mortgages and other obligations. San Jose Water Company, a subsidiary of SJW Corp., has received advance deposit payments from its customers on construction projects. Refunds of the advance deposit payments constitute an obligation of San Jose Water Company. Note 9. Sale of Nonutility Property - ------------------------------------ On September 30, 2005, SJW Land Company sold 2.6 acres of property located at Reservoir Road, Los Gatos, California for $4,200,000. SJW Corp. recognized a gain on the sale of nonutility property of $1,095,000, net of tax of $761,000. Note 10. Subsequent Event - ------------------------- On October 4, 2005, SJWTX Water, Inc. (SJWTX Water), a newly formed Texas corporation and wholly owned subsidiary of SJW Corp., entered into an agreement to purchase substantially all of the assets of Canyon Lake Water Supply Corporation (CLWSC), a Texas nonprofit water supply corporation. CLWSC is a member-owned nonprofit water utility headquartered in Canyon Lake, Texas. CLWSC serves a population of approximately 20,000 with more than 6,700 connections in western Comal County and southern Blanco County. The purchase price of CLWSC consists of $3.2 million in cash payable to CLWSC at closing, SJWTX Water's assumption, retirement or recapitalization of all of CLWSC's outstanding debt and bond obligations of approximately $20 million and SJWTX Water's payment of certain CLWSC transaction expenses. The acquisition will be subject to the satisfaction of various conditions set forth in the agreement, including the approval by the members of CLWSC and the Texas Commission on Environmental Quality and other approvals required under the parties' governing documents and applicable laws and regulations. Members of CLWSC will vote on the purchase on November 5, 2005. If approved, SJWTX Water and CLWSC will file applications with the regulatory agencies for governmental approval and would expect resolution of such filings in the fall of 2006. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL ------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS ----------------------------------- This report contains forward-looking statements within the meaning of the federal securities laws relating to future events and future results of SJW Corp. and its subsidiaries that are based on current expectations, estimates, forecasts, and projections about SJW Corp. and the industries in which SJW Corp. operates and the beliefs and assumptions of the management of SJW Corp. Such forward-looking statements are identified by words including "expect", "estimate", "anticipate", "intends", "plans", "may", "should", "will" and 13
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 under the section entitled "Factors that May Affect Future Results" under this Item 2 and elsewhere, and in other reports SJW Corp. files with the Securities and Exchange Commission (SEC), specifically the most recent reports on Form 10-K, Form 10-Q and Form 8-K, each as it may be amended from time to time. SJW Corp. undertakes no obligation to update 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 Corp. is a holding company with four subsidiaries. San Jose Water Company, a wholly owned subsidiary of SJW Corp., is a public utility in the business of providing water service to a population of approximately one million people in an area comprising about 138 square miles in the metropolitan San Jose area. The principal business of San Jose Water Company consists of the production, purchase, storage, purification, distribution and retail sale of water. San Jose Water Company provides water service to customers in portions of the cities of Cupertino and San Jose and in the cities of Campbell, Monte Sereno, Saratoga and the Town of Los Gatos, and adjacent unincorporated territory, 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 nonregulated water related services under agreements with municipalities. These nonregulated services include full water system operations, billings and cash remittance services. SJW Land Company, a wholly owned subsidiary of SJW Corp., owns and operates parking facilities, which are located adjacent to San Jose Water Company's headquarters and the HP Pavilion in San Jose, California. SJW Land Company also owns commercial buildings, other undeveloped land primarily in the San Jose Metropolitan area, some properties in the states of Florida and Connecticut, and a 70% limited partnership interest in 444 West Santa Clara Street, L.P. The limited partnership has been determined to be a Variable Interest Entity within the scope of FIN 46R, and as a result, it has been consolidated with SJW Land Company. Crystal Choice Water Service LLC, a subsidiary 75% owned by SJW Corp., engages in the sale and rental of water conditioning and purification equipment. In the third quarter of 2005, SJW Corp. formed a Texas corporation, SJWTX Water, Inc. (SJWTX Water). SJWTX Water has entered into an agreement to purchase Canyon Lake Water Supply Corporation, as discussed in note 10. 14
SJW Corp. also owns 1,099,952 shares of California Water Service Group, which represents approximately 6% of its outstanding shares as of September 30, 2005. Business Strategy: - ------------------ SJW Corp. focuses its business initiatives in four strategic areas: (1) Regional regulated utility operations in the San Jose metropolitan area. (2) Regional nonregulated water and utility-related services provided in accordance with the guidelines established by the California Public Utilities Commission (CPUC). (3) Real estate development and investment activities in SJW Land Company. (4) Out-of-region water and utility-related services, primarily in the Western United States. Regional Regulated Activities ----------------------------- SJW Corp.'s regulated utility operation is conducted through San Jose Water Company, a wholly owned water utility subsidiary. SJW Corp. effectively plans and applies a disciplined approach to improving and maintaining its water system infrastructure. It also seeks to acquire regulated water systems adjacent to or near its existing service territory. Regional Nonregulated Activities -------------------------------- Operating in accordance with guidelines established by the CPUC, San Jose Water Company provides nonregulated water services under agreements with municipalities and other utilities. Nonregulated services include water system operations, billings and cash remittance processing, maintenance services, and telecommunication antenna leasing. San Jose Water Company also seeks appropriate nonregulated business opportunities that complement its existing operations or that allow it to extend its core competencies beyond existing operations. San Jose Water Company seeks opportunities to fully utilize its capability and existing capacity by providing services to other regional water systems, benefiting its existing regional customers through increased efficiencies and revenue sharing. Real Estate Development and Investment -------------------------------------- SJW Land Company's real estate investments diversifies SJW Corp.'s asset base and balances SJW Corp.'s concentration in regulated assets. SJW Land Company implements its strategy by exchanging selected real estate assets for high quality, relatively low risk investments with a capital structure and risk and return profile that is consistent with SJW Corp.'s consolidated capital structure and risk and return profile. 15
Out-of-Region Opportunities --------------------------- SJW Corp. is also pursuing opportunities to participate in out-of-region water and utility-related services, particularly regulated water businesses, in the Western United States. SJW Corp. systematically evaluates out-of-region and out-of-state opportunities primarily in regulated water businesses that meet SJW Corp.'s risk and return profile. The factors SJW Corp. considers in evaluating such opportunities include: * regulatory environment; * synergy potential; * general economic conditions; * additional growth opportunities within the region; * water quality and environmental issues; and * capital requirements. SJW Corp. cannot be certain it will be successful in locating appropriate opportunities in all of the above business activities and initiatives in the region and out-of-region and if it does, in consummating any transactions relating to such opportunities. In addition, any transaction will involve numerous risks. These include the possibility of paying more than the value derived from the acquisition, the assumption of certain known and unknown liabilities of the acquired assets, the risk of diverting management's attention from normal daily operations of the business, negative impact to our financial condition and operating results, the risks of entering markets in which we have no or limited direct prior experience and the potential loss of key employees of any acquired company. SJW Corp. cannot be certain that any transaction will be successful and will not materially harm its operating results or financial condition. Critical Accounting Policies: - ----------------------------- SJW Corp. has identified the accounting policies below as the policies critical to its business operations and the understanding of the results of operations. The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements, and revenues and expenses during the reporting period. SJW Corp. bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. The impact and any associated risks related to these policies on SJW Corp.'s business operations is discussed throughout "Management's Discussion and Analysis of Financial Condition and Results of Operations" where such policies affect SJW Corp.'s reported and expected financial results. SJW Corp.'s critical accounting policies are as follows: 16
Balancing Account ----------------- The CPUC establishes the balancing account mechanism to track the under-collection and over-collection of CPUC authorized revenue associated with expense changes for purchased water, purchased power and pump tax. Since balances are tracked and subject to approval by the CPUC before they can be incorporated into rates, San Jose Water Company has not recognized the balancing account in its financial statements. The balance of the balancing account varies with the seasonality of the water utility business such that during the summer months when the demand for water is at its peak, the balancing account tends to reflect an under-collection, while during the winter months when demand for water is relatively lower, the balancing account tends to reflect an over-collection. Had the balancing account been recognized in San Jose Water Company's financial statements, San Jose Water Company's retained earnings would be decreased by the amount of balancing account over-collection, as the case may be, or increased by the amount of balancing account under-collection, less applicable taxes. Revenue Recognition ------------------- San Jose Water Company's revenue from metered customers includes billing to customers based on meter readings plus an estimate of water used between the customers' last meter reading and the end of the accounting period. San Jose Water Company reads the majority of its customers' meters on a bi-monthly basis and records its revenue based on its meter reading results. Revenue from the meter reading date to the end of the accounting period is estimated based on historical usage patterns, production records and the effective tariff rates. The estimate of the unbilled revenue is a management estimate utilizing certain sets of assumptions and conditions which include the number of days between meter reads for each billing cycle, the customers' consumption changes, and the San Jose Water Company's experiences in unaccounted-for water. Actual results could differ from those estimates, which would result in adjusting the operating revenue in the period which the revision to San Jose Water Company's estimates are determined. As of September 30, 2005 and December 31, 2004, accrued unbilled revenue was $15,249,000 and $6,605,000, respectively. SJW Corp. recognizes its nonregulated revenue based on the nature of the nonregulated business activities. Revenue from San Jose Water Company's nonregulated utility operations and billing or maintenance agreements are recognized when services have been rendered. Revenue from SJW Land Company is recognized ratably over the term of the lease or when parking services have been rendered. Revenue from Crystal Choice Water Service LLC is recognized at the time of the delivery of water conditioning and purification equipment or ratably over the term of the lease of the water conditioning and purification equipment. Recognition of Regulatory Assets and Liabilities ------------------------------------------------ Generally accepted accounting principles for water utilities include the recognition of regulatory assets and liabilities as permitted by SFAS No. 71, "Accounting for the Effects of Certain Types of Regulation". In accordance with SFAS No. 71, San Jose Water Company records deferred costs and credits on the balance sheet as regulatory assets and liabilities when it is probable that these costs and credits will be recovered in the ratemaking process in a period different from when the costs and credits were incurred. Accounting for such costs and credits is based on management's judgment that it is probable that the 17
costs will be recoverable in the future revenue of San Jose Water Company through the ratemaking process. The regulatory assets and liabilities recorded by San Jose Water Company primarily relate to the recognition of deferred income taxes for ratemaking versus tax accounting purposes. The disallowance of any asset in the future for ratemaking purposes, including the deferred regulatory assets, would require San Jose Water Company to immediately recognize the impact of the costs for financial reporting purposes. No disallowance had to be recognized as of September 30, 2005 and December 31, 2004. The net regulatory assets recorded by San Jose Water Company as of September 30, 2005 and December 31, 2004 was $7,227,000 and $8,064,000, respectively. Income Taxes ------------ SJW Corp. estimates its federal and state income taxes as part of the process of preparing the financial statements. The process involves estimating the actual current tax exposure together with assessing temporary differences resulting from different treatment of items for tax and accounting purposes, including the evaluation of the treatment acceptable in the water utility industry and its regulatory agency. These differences result in deferred tax assets and liabilities, which are included in the balance sheet. If actual results, due to changes in regulatory treatment, or significant changes in tax-related estimates or assumptions or changes in law, differ materially from these estimates, the provision for income taxes will be materially impacted. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period that includes the enactment date. Pension Accounting ------------------ San Jose Water Company offers a defined benefit plan, Supplemental Executive Retirement Plan and certain post-retirement benefits other than pensions to employees retiring with a minimum level of service. Accounting for pensions and other post-retirement benefits requires an extensive use of assumptions about the discount rate, expected return on plan assets, the rate of future compensation increases received by the employees, mortality, turnover and medical cost increases. San Jose Water Company, through its Retirement Plan Administrative Committee (the Committee) managed by the representatives from the unions and management, establishes investment guidelines which specify that at least 30% of the investments are in bonds or cash. As of December 31, 2004, the plan assets consisted of approximately 30% bonds, 2% cash and 68% equities. The committee requires that equities be diversified by industry groups to balance for capital appreciation and income. In addition, all investments are publicly traded. San Jose Water Company uses an expected rate of return on plan assets of 8% in its actuarial computation. The distribution of assets is not considered highly volatile and sensitive to changes in market rates and prices. Furthermore, foreign assets are not included in the investment profile and thus risk related to foreign exchange fluctuation has been eliminated. 18
The plan assets are marked to market at the measurement date. The investment trust assets incurred unrealized market losses in the years prior to 2004. Unrealized market losses on pension assets are amortized over 14 years for actuarial expense calculation purposes. San Jose Water Company utilizes Moody's `A' and `Aa' rated bonds in industrial, utility and financial sectors with outstanding amount of $1,000,000 or more in determining the discount rate used in calculating the pension and other postretirement benefit liabilities at the measurement date. For the year ending December 31, 2004, the composite discount rate used was 6.00%. Stock-Based Compensation Plans ------------------------------ SJW Corp. has a stockholder-approved long-term incentive plan that allows granting of nonqualified stock options, performance shares, deferred restricted stock awards and dividend awards. Under the plan, a total of 900,000 common shares have been authorized for awards and grants. SJW Corp. has adopted Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation", utilizing the Black-Scholes option-pricing model to compute the fair value of options at grant date as basis for the stock-based compensation for financial reporting purposes. The weighted-average assumptions utilized for 2005 include: expected dividend yield of 2.6%, expected volatility of 24.3%, risk-free interest rate of 3.67%, expected holding period of five years. In addition to option grants, SJW Corp. has granted deferred restricted stock awards to a key employee of SJW Corp., which were valued at market price at the date of grant. SJW Corp. is recognizing the fair market value of the deferred restricted stock awards granted as compensation expense, over the vesting period of three years as services are rendered. Additionally, deferred restricted stock awards granted to non-employee board members from the conversion of cash pension benefits were valued at market price at the date of grant. SJW Corp. is correspondingly recognizing the fair market value of the unvested deferred restricted stock granted as compensation expense, over the vesting period of three years as services are rendered. Consolidation Policy of Majority-Owned Enterprises -------------------------------------------------- SJW Corp. consolidates its 75% controlling interest of Crystal Choice Water Service LLC in its Financial Statement with the 25% minority interest included as "other" in the Consolidated Statements of Income and Comprehensive Income and in "other noncurrent liabilities" on the Balance Sheet. Effective January 1, 2004, SJW Corp. adopted FASB Interpretation No. 46R, (FIN46R) "Consolidation of Variable Interest Entities". As a result of the adoption of FIN46R, SJW Corp. has identified its investment in 444 West Santa Clara Street, L.P. as a variable interest entity and SJW Land Company as the primary beneficiary. SJW Corp. consolidates its 70% limited partnership interest in 444 West Santa Clara Street, L.P. with the 30% minority interest included as "other" in the Consolidated Statements of Income and Comprehensive Income and in "other noncurrent liabilities" on the Balance Sheet. 19
Recognition of Gain/Loss on Nonutility Property ----------------------------------------------- In compliance with the Uniform Systems of Accounts (USOA) prescribed by the CPUC and conforming to generally accepted accounting principles for rate-regulated public utilities, the cost of retired utility plant, including retirement costs (less salvage), is charged to accumulated depreciation and no gain or loss is recognized for utility plant used and useful in providing water utility services to customers. Nonutility property in San Jose Water Company is property that is neither used nor useful in providing water utility services to customers and is excluded from the rate base for rate-setting purposes. San Jose Water Company recognizes gain/loss on disposition of nonutility property in accordance with CPUC Code Section 790. Nonutility property in SJW Land Company and Crystal Choice Water Service LLC consists primarily of land, buildings, parking facilities and water conditioning equipment. Net gains or losses from the sale of nonutility property are recorded as a component of other income (expense) in the consolidated statement of income and comprehensive income. Recent Accounting Pronouncements: - --------------------------------- In December 2004, the Financial Accounting Standards Board issued a revised Statement No. 123, Share-Based Payment (Statement 123(R)), which addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise's equity instruments or that may be settled by the issuance of such equity instruments. Statement 123(R) requires an entity to recognize the grant-date fair-value of stock options and other equity-based compensation issued to employees in the income statement. Statement 123(R) generally requires that an entity account for those transactions using the fair-value-based method. Statement 123(R) is effective for SJW Corp. on January 1, 2006. SJW Corp. is utilizing a fair value option pricing model in calculating its options expense, which is an acceptable method under Statement 123(R), therefore, the adoption of Statement 123(R) is not expected to have a material impact on SJW Corp.'s financial position, results of operations or cash flows. In December 2004, the Financial Accounting Standards Board issued FASB Statement No. 153 (Statement 153), Exchanges of Productive Assets: an Amendment of Opinion No. 29. As part of its short-term international convergence project with the International Accounting Standard Board (IASB), on December 16, 2004, the FASB issued Statement 153 to address the accounting for non-monetary exchanges of productive assets. Statement 153 amends APB No. 29, Accounting for Non-monetary Exchanges, which established a narrow exception for non-monetary exchanges of similar productive assets from fair value measurement. Statement 153 eliminates that exception and replaces it with an exception for exchanges that do not have commercial substance. Under Statement 153, non-monetary exchanges are required to be accounted for at fair value, recognizing any gains or losses, if the fair value is determinable within reasonable limits and the transaction has 20
commercial substance. Statement 153 specifies that a non-monetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. An entity should apply the provisions of Statement 153 prospectively for non-monetary asset exchange transactions in fiscal periods beginning after June 15, 2005. The adoption of Statement 153 is not expected to have a material impact on SJW Corp.'s financial position, results of operations or cash flows. In March 2005, the Financial Accounting Standards Board issued Interpretation No. 47 (Interpretation 47), Accounting for Conditional Asset Retirement Obligations. Interpretation 47 clarifies that the term "conditional asset retirement obligation" used in FASB Statement No. 143, Accounting for Asset Retirement Obligations, refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. This interpretation is effective no later than the end of fiscal years ending after December 15, 2005. The adoption of Interpretation 47 is not expected to have a material impact on SJW Corp.'s financial position, results of operations or cash flows. In May 2005, the Financial Accounting Standards Board issued Statement No. 154 (Statement 154), Accounting Changes and Error Corrections: a replacement of APB Opinion No. 20 and FASB Statement No. 3. Under Statement No. 154, if the cumulative effect of the change in accounting principle can be determined, but it is impracticable to determine the specific effects of an accounting change on one or more prior periods presented, the change in accounting principle will have to be applied to the balances of assets and liabilities as of the beginning of the earliest period for which retrospective application is practicable, with a corresponding adjustment made to the opening balance of retained earnings or other components of equity for that period. If it is impracticable to determine the cumulative effect of applying a change in accounting principle, the new accounting principle is to be applied prospectively from the earliest date practicable. If retrospective application for all prior periods is impracticable, the method used to report the change and the reason that retrospective application is impracticable are to be disclosed. The requirements for Statement 154 are effective for accounting changes made in fiscal years beginning after December 15, 2005. The adoption of Statement 154 is not expected to have a material impact on SJW Corp.'s financial position, results of operations or cash flows. Liquidity and Capital Resources: - -------------------------------- San Jose Water Company's budgeted capital expenditures for 2005, exclusive of capital expenditures financed by customer contributions and advances, are $33,761,000 with capital expenditures concentrated in water main replacements. Approximately $23,000,000 will be spent to replace San Jose Water Company's mains in 2005. Out of the total budgeted capital expenditures of $33,761,000, $21,853,000 has been spent as of September 30, 2005. Starting in 1997, San Jose Water Company began a four-phased Infrastructure Study establishing a systematic approach to replace its utility infrastructure. Phases I and II of the Infrastructure Study analyzed San Jose Water Company's pipes and mains. Phases III and IV examined all other utility facilities. The Infrastructure Study was completed in July 2002 and is being used as a guide for future capital improvement programs. It will also serve as the master plan for San Jose Water Company's future improvements. 21
San Jose Water Company's capital expenditures are incurred in connection with normal upgrading and expansion of existing facilities and to comply with environmental regulations. San Jose Water Company expects to incur approximately $187,000,000 in capital expenditures, which includes replacement of pipes and mains, and maintaining existing water systems, over the next five years, exclusive of customer contributions and advances. San Jose Water Company's actual capital expenditures may vary from its 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 exceed company-financed additions by several million dollars as a result of new facilities construction funded with advances from developers and contributions in aid of construction. A substantial portion of San Jose Water Company's distribution system was constructed during the period from 1945 to 1980. San Jose Water Company expects that expenditure levels for renewal and modernization of this part of the system will grow at an increasing rate as these 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. As of September 30, 2005, SJW Corp.'s share of capital investment in Crystal Choice Water Service LLC approximated 75%. SJW Corp. does not expect to make significant cash contributions to Crystal Choice Water Service LLC in 2005. Historically, San Jose Water Company's write-offs for uncollectible accounts represent less than 1% of its total revenue. Management believes it can continue to collect its accounts receivable balances at its historical collection rate. Sources of Capital: - ------------------- San Jose Water Company's ability to finance future construction programs and sustain dividend payments depends on its ability to attract external financing and maintain or increase internally generated funds. 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. San Jose Water Company's financing activity is designed to achieve a capital structure consistent with regulatory guidelines of approximately 50% debt and 50% equity. As of September 30, 2005, San Jose Water Company's funded debt and equity were 46.2% and 53.8%, respectively. Historically, San Jose Water Company's internally generated funds, which include allowances for depreciation and deferred income taxes, have provided approximately 50% of the cash requirements for San Jose Water Company's capital expenditure. Due to its strong cash position and low financial leverage 22
condition, funding for its future capital expenditure program will be provided primarily through long-term debt. San Jose Water Company and its parent, SJW Corp., do not currently anticipate the issuance of any common equity to finance future capital expenditures. San Jose Water Company has outstanding $130,000,000 of unsecured senior notes as of June 30, 2005. The senior note agreements of San Jose Water Company generally have terms and conditions that restrict San Jose Water Company from issuing additional funded debt if (1) the funded debt would exceed 66-2/3% of total capitalization, and (2) net income available for interest charges for the trailing 12 calendar month period would be less than 175% of interest charges. As of September 30, 2005, San Jose Water Company's funded debt was 46.2% of total capitalization and the net income for the preceding 12 months was 474% of interest charges. In 2002, the California Department of Water Resources approved San Jose Water Company's application for an approximately $2,500,000 Safe Drinking Water State Revolving Fund (SDWSRF) 20-year loan at an interest rate of 2.39%. The funds in the above amount were obtained for modifications made to San Jose Water Company's Saratoga Water Treatment Plant. On June 15, 2005, $1,953,000 was funded. San Jose Water Company expects to receive funding for the remaining qualified amount in the fourth quarter of 2005. In 2004, the California Department of Water Resources approved San Jose Water Company's application for a second loan under the SDWSRF program. The loan is for approximately $1,660,000 over a term of 20-years at an interest rate of 2.60%. These funds will be used for water treatment plant improvements to meet increasing filtration standards. San Jose Water Company expects to receive the funding of this loan in 2005 when all documentation has been completed. In connection with the acquisition of two properties in the states of Connecticut and Florida in April 2003, SJW Land Company executed mortgages in the aggregate amount of $9,900,000 in April 2003. The mortgage loans have an original maturity of 10 years and are being amortized over 25 years with a fixed interest rate of 5.96% and are secured by the two properties in the states of Connecticut and Florida. The loan agreements generally restrict SJW Land Company from prepayment in the first five years and require submission of periodic financial reports as part of the loan covenants. The properties were leased to a multinational organization for a term of 20-years. The 444 West Santa Clara Street, L.P., in which SJW Land Company owns a 70% limited partnership interest, has a mortgage loan in the outstanding amount of $4,185,000 as of September 30, 2005. The mortgage loan is due in April 2011 and amortized over 25 years with a fixed interest rate of 7.80%. The mortgage loan is secured by the partnership's real property and is non-recourse to SJW Land Company. In connection with the nonutility property condemnation in the fourth quarter of 2004 and the nonutility property sale in the third quarter of 2005, SJW Land 23
Company intends to identify replacement property and reinvest the proceeds in order to qualify the transactions under Internal Revenue Code sections 1033 and 1031, by November 2006 and December 2005, respectively. SJW Corp. and its subsidiaries have unsecured lines of credit available allowing aggregate short-term borrowings of up to $30,000,000 at rates that approximate the bank's prime or reference rate. As of September 30, 2005, SJW Corp. and its subsidiaries had available unused short-term bank lines of credit of $30,000,000. The lines of credit expire on July 1, 2006. Results of Operations: - ---------------------- Overview -------- SJW Corp.'s consolidated net income for the three months ended September 30, 2005 was $9,227,000, an increase of $3,697,000 or 67% from $5,530,000 for the three months ending September 30, 2004. For the nine months ended September 30, 2005, earnings was $17,623,000, an increase of $5,512,000 or 46% from $12,111,000 for the same period in 2004. On September 30, 2005, SJW Land Company sold nonutility property for $4,200,000. SJW Corp. recognized a gain on the sale of nonutility property of $1,095,000, net of tax of $761,000. Operating Revenue ----------------- <TABLE> <CAPTION> Operating Revenue by Subsidiary Three Months Ended Nine Months Ended September 30, September 30, 2005 2004 2005 2004 ---- ---- ---- ---- (in thousands) <S> <C> <C> <C> <C> San Jose Water Company $57,387 51,086 $133,280 124,926 SJW Land Company 751 786 2,315 2,713 Crystal Choice Water Service LLC 331 425 980 1,330 ------- ------ -------- ------- $58,469 52,297 $136,575 128,969 ======= ====== ======== ======= </TABLE> <TABLE> <CAPTION> The change in consolidated operating revenue was due to the following factors: Three Months Ended Nine Months Ended September 30, 2005 vs 2004 September 30, 2005 vs 2004 Increase/(decrease) Increase/(decrease) ------------------- ------------------- Utility: (in thousands) <S> <C> <C> <C> <C> Consumption changes $ (319) (1%) $(8,430) (7%) New customers increase 292 1% 679 - Rate increases 6,328 12% 16,105 13% Parking and rental (35) - (398) - Crystal Choice Water Service LLC (94) - (350) - ------ --- ------- --- $6,172 12% $ 7,606 6% ====== === ======= === </TABLE> 24
Operating Expenses ------------------ <TABLE> <CAPTION> Operating Expenses by Subsidiary Three Months Ended Nine Months Ended September 30, September 30, 2005 2004 2005 2004 ---- ---- ---- ---- (in thousands) <S> <C> <C> <C> <C> San Jose Water Company $47,202 43,504 $110,566 106,889 SJW Land Company 416 435 1,363 1,412 Crystal Choice Water Service LLC 471 437 1,242 1,318 SJW Corp. 117 181 425 515 ------- ------ -------- ------- $48,206 44,557 $113,596 110,134 ======= ====== ======== ======= </TABLE> The change in operating expenses from the same period in 2004 was due to the following factors: <TABLE> <CAPTION> Three Months Ended Nine Months Ended September 30, 2005 vs 2004 September 30, 2005 vs 2004 Increase/(decrease) Increase/(decrease) ------------------- ------------------- (in thousands) Water production costs: <S> <C> <C> <C> <C> Increased surface water supply $ (594) (1%) $ (696) (1%) Usage decrease (333) (1%) (5,788) (5%) Pump tax and purchased water price increase 742 2% 2,859 3% Other 84 - 213 - ------- -- ------- -- Total water production costs (101) - (3,412) (3%) ------- -- ------- -- Nonwater production costs: Administrative and general 849 2% 1,643 1% Other operating expense 593 1% 664 1% Maintenance 36 - 130 - Property taxes and other nonincome taxes 124 - 232 - Depreciation and amortization 353 1% 1,139 1% ------- -- ------- -- Total nonwater production costs 1,955 4% 3,808 3% ------- -- ------- -- Income taxes 1,795 4% 3,066 3% ------- -- ------- -- Total operating expenses $ 3,649 8% $ 3,462 3% ======= == ======= == </TABLE> San Jose Water Company's water supply consists of groundwater from wells, surface water from watershed run-off and diversion, and water purchased from the SCVWD. Surface water is the least expensive source of water and its availability significantly impacts the water production costs of San Jose Water Company. 25
Water production for the three months and nine months ended September 30, 2005 decreased 178 million gallons and 3,759 million gallons from the same periods in 2004. During these periods, more surface water was used when compared to the same periods in 2004. The change in San Jose Water Company's source of supply mix was as follows: <TABLE> <CAPTION> Three Months Ended Nine Months Ended September 30, 2005 vs. 2004 September 30, 2005 vs. 2004 Increase/(decrease) Increase/(decrease) ------------------- ------------------- (in million gallons) <S> <C> <C> <C> Purchased water 443 3% (1) - Surface water 391 2% 458 1% Ground water (999) (6%) (4,124) (10%) Reclaimed water (13) - (92) - ------- ---- ------- ----- (178) (1%) (3,759) (9%) ======= ==== ======= ===== </TABLE> The changes in the source of supply mix were consistent with the changes in the water production costs. Nonwater production costs include administrative costs which contains costs for employee benefits and salaries and wages. The increase of nonwater production costs for the third quarter of 2005 from the third quarter of 2004 consisted principally of $849,000 in general and administrative costs, which includes a $356,000 increase in employee benefits' costs, $265,000 in professional services and $228,000 in salaries and other expenses. In addition, other operating expenses increased $593,000, taxes other than income increased $124,000 and depreciation expense increased $353,000 as a result of growth in utility plant. Income tax expense for the third quarter and nine months ended September 30, 2005 increased by $1,795,000 and $3,066,000, respectively, over the same periods in 2004 due to higher earnings in 2005. The effective income tax rates for the periods ended September 30, 2005 and 2004 approximated 41%. The changes in comprehensive income for the three and nine months ended September 30, 2005 and 2004 were due to the changes in market value of the investment in California Water Service Group. Factors That May Affect Future Results: - -------------------------------------- Water Supply and Energy Resources --------------------------------- San Jose Water Company's water supply is obtained from wells, groundwater, watershed run-off and diversion, surface water and by import water purchases 26
from the SCVWD under the terms of a master contract with SCVWD expiring in 2051. Groundwater level in 2005 remains comparable to the 30-year normal level. On October 3, 2005, the SCVWD's 10 reservoirs were 68.2% full with 115,223 acre-feet of water in storage. The rainfall in the first nine months of 2005 was approximately 151% of historical season average. Rainfall at San Jose Water Company's Lake Elsman was measured at 59.84 inches for the season of July 1, 2004 through September 30, 2005, which is 148.5% of the five-year average. No rainfall was recorded at Lake Elsman during the period from July 1, 2005 to September 30, 2005, which is consistent with the 5-year average. Local surface water is a less costly source of water and its availability significantly impacts San Jose Water Company's results of operations. Based on information provided by SCVWD in its Water Utility Enterprise Report, San Jose Water Company believes that its various sources of water supply are sufficient to meet customer demand for the remainder of the year. To the extent that San Jose Water Company has to pump water during peak periods to satisfy customer demand when imported water is not available, higher energy costs will be incurred. Currently, the CPUC has no established procedure for water utilities to recover the additional costs incurred due to such unanticipated changes in water supply mix. There can be no assurance that such costs will be recovered in full or in part. Security Issues --------------- San Jose Water Company has taken steps to increase security at its water utility facilities and continues to implement a comprehensive security upgrade program for production and storage facilities, booster pump stations and company buildings. San Jose Water Company also coordinates security and planning information with eight other large regional water utilities within the San Francisco Bay area, as well as various governmental and law enforcement agencies. San Jose Water Company conducted a system-wide vulnerability assessment in compliance with federal regulations that Public Law 107-188 imposed on all water utilities. The assessment report was filed with the government on March 31, 2003. The vulnerability assessment identified system security enhancements that impact water quality, health, safety and continuity of service totaling approximately $2,300,000. These improvements have been incorporated into the capital budgets for 2005. San Jose Water Company is continuing implementation of security related to capital improvements in 2005 and $765,000 is expected to be incurred in 2005. As of September 30, 2005, $564,000 has been incurred. Once completed, San Jose Water Company believes it will have substantially reduced its vulnerability to hostile aggression. San Jose Water Company has and will continue to bear costs associated with additional security precautions to protect its water utility business and other operations. San Jose Water Company actively participated in the security vulnerability assessment training offered by the American Water Works Association Research Foundation and the Environmental Protection Agency. 27
Regulatory Affairs ------------------ Almost all of the operating revenue of San Jose Water Company results from the sale of water at rates authorized by the California Public Utilities Commission (CPUC). The CPUC sets rates that are intended to provide revenue sufficient to recover operating expenses and produce a reasonable return on common equity. The timing of the rate decision could have an impact on the results of operations. On August 19, 2004, the CPUC issued the final decision (D.04-08-054) in San Jose Water Company's General Rate Case Application. The decision granted San Jose Water Company authority to increase rates by $11,773,000 or 8% in 2004, $4,283,000 or 2.69% in 2005 and $4,245,000 or 2.59% in 2006. The authorized return on common equity in 2004, 2005 and 2006 is 9.9%, which is within the range of recent rates of return authorized by the CPUC for water utilities. San Jose Water Company was also authorized to recover the current balance of $71,000 in its Water Contamination Memorandum Account, as well as recovery of an under-collection of $382,000 accrued in its pre-November 29, 2001 Balancing Account. The new authorized rates became effective August 24, 2004. Pursuant to Public Utilities Code Section 455.2, San Jose Water Company is allowed to recover, via a 12-month Quantity Rate surcharge authorized by the CPUC effective January 1, 2005, $4,968,000 of under-collected revenue due to regulatory delay in implementation of new rates in 2004. Additionally, the scheduled rate increase of $4,283,000 described above was also authorized by the CPUC effective January 1, 2005. Pursuant to the CPUC's general rate case decision (D.04-08-054), on January 25, 2005, San Jose Water Company filed an advice letter requesting authorization to increase rates by $785,000 via a rate base offset for plant additions completed at San Jose Water Company's Saratoga Water Treatment Plant and their Montevina Water Treatment Plant. This rate increase became effective May 13, 2005. Effective July 1, 2005, the CPUC approved a request for a revenue increase of $2.1 million to recover the increased cost of purchased water and higher pump tax charged to San Jose Water Company by the SCVWD. Balancing Account Recovery Procedures ------------------------------------- On March 16, 2004, the CPUC affirmed its June 19, 2003 decision (D.03-06-072), in which the CPUC revised the existing procedures for recovery of under-collections and over-collections in balancing accounts existing on or after November 29, 2001 as follows: (1) If a utility is within its rate case cycle and is not over-earning, the utility shall recover its balancing account subject to reasonableness review; and (2) If a utility is either within or outside of its rate case cycle and is over-earning, the over-earnings will be used as a measure by which recovery of offset expenses in the balancing account 28
will be reduced. For example, if the amount of the over-earning is equal to or exceeds the amount of offset expenses to be recovered in the balancing account, those expenses shall be reduced to zero. Any offset expenses accumulated in the balancing account would be amortized as other expenses and any offset revenues collected in the balancing account would be returned to ratepayers. Utilities shall use the recorded rate of return means test to evaluate earnings for all years. The expenses used in this earnings test shall be adjusted for any "extraordinary" expenses and revenue shall be adjusted for any "extraordinary" revenue. The earnings test will use recorded rate base. Utilities must file for recovery of the balancing account balances before March 31 of every year. On September 9, 2003 and March 30, 2004, San Jose Water Company filed two compliance filings requesting CPUC review of the balancing account over-collected balance of approximately $382,000, accrued between November 29, 2001 and December 31, 2003. On June 15, 2004, the CPUC notified San Jose Water Company that the over-collected balances had been verified and should be carried forward to the next review period. As of September 30, 2005 and December 31, 2004, the approved balance is an over-collection of $394,000 and $389,000, respectively, including interest on approved amounts. On March 30, 2005, San Jose Water Company filed a compliance filing requesting the CPUC review of the balancing account under-collected balance of approximately $999,000, accrued between January 1, 2004 and December 31, 2004. The CPUC has not completed its review of the balance and the final amount that San Jose Water Company is allowed to carry over could change. Effective July 1, 2005, the CPUC approved a request for a revenue increase of $2.1 million to recover the increased cost of purchased water and higher pump tax charged to San Jose Water Company by the SCVWD. The increased costs and associated rate revenue is now being tracked in the Memorandum Type Balancing Account, subject to review by the CPUC. There have also been changes in the purchased power costs in 2005 that affect the balancing account for 2005. San Jose Water Company does not anticipate the changes in the balancing account to be material. The following is a summary of the balancing account: <TABLE> <CAPTION> September 30, 2005 December 31, 2004 ------------------ ----------------- <S> <C> <C> Over-collected balancing account 11/29/01 to 12/31/03 $ (382) $ (382) Under-collected balancing account 1/1/2004 to 12/31/2004 999 999 Under-collected Memorandum Type Balancing Account 7/1/2005 to 9/30/2005 73 - ------- ------- Subtotal 690 617 Interest on approved amounts (12) (7) ------- ------- Net under-collected balancing account $ 678 $ 610 ======= ======= </TABLE> 29
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ---------------------------------------------------------- SJW Corp. is subject to market risks in the normal course of business, including changes in interest rates and equity prices. The exposure to changes in interest rates is a result of financings through the issuance of fixed-rate, long-term debt and short-term funds obtained through the variable rate line of credit. SJW Corp. also owns 1,099,952 shares of California Water Service Group and is exposed to the risk of changes in equity prices. SJW Corp. has no derivative financial instruments, financial instruments with significant off-balance sheet risks, or financial instruments with concentrations of credit risk. There is no material sensitivity to change in market rates and prices. ITEM 4. CONTROLS AND PROCEDURES ----------------------- (a) SJW Corp.'s management, with the participation of the SJW Corp.'s Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of SJW Corp.'s disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that SJW Corp.'s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report have been designed and are functioning effectively to provide reasonable assurance that the information required to be disclosed by SJW Corp. in reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms. SJW Corp. believes that a control system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the control system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected. (b) There has been no change in internal control over financial reporting during the third fiscal quarter of 2005 that has materially affected, or is reasonably likely to materially affect the internal controls over financial reporting of SJW Corp. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS ----------------- SJW Corp. is subject to ordinary routine litigation incidental to its business. There are no pending legal proceedings to which SJW Corp. 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 Corp.'s financial position, results of operations or cash flows. 30
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF -------------------------------------------------------------- EQUITY SECURITIES ----------------- On April 29, 2004, SJW Corp. announced that its board of directors authorized a stock repurchase program to repurchase up to 100,000 shares of its outstanding common stock over the 36 months period following its announcement. Below is the information regarding shares repurchased by SJW Corp. during 2005. <TABLE> <CAPTION> Total Number of Maximum Number of Total Number Shares Purchased as Shares That May of Shares Average Price Part of Publicly Yet Be Purchased Period Purchased Paid per Share Announced Plan Under the Plan ------ --------- -------------- -------------- -------------- <S> <C> <C> <C> <C> May 1, 2005- May 31, 2005 4,736 $39.05 4,736 90,969 Total 4,736 $39.05 4,736 90,969 ===== ====== ===== ====== </TABLE> There were no shares repurchased during the months of April and June 2005. In addition, there were no shares purchased during the first quarter and third quarter of 2005. As of September 30, 2005, the total shares repurchased since inception of the plan were 9,031. ITEM 5. OTHER INFORMATION ----------------- On October 27, 2005, the Board of Directors of SJW Corp. declared the regular quarterly dividend of $0.2675 per common share. The dividend will be paid December 1, 2005, to shareholders of record as of the close of business on November 7, 2005. ITEM 6. EXHIBITS -------- See Exhibit Index located immediately following the Certification of this document, which is incorporated herein by reference as required to be filed by Item 601 of Regulation S-K for the quarter ended on September 30, 2005. 31
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. SJW CORP. DATE: November 4, 2005 By /s/ Angela Yip ----------------- ANGELA YIP Chief Financial Officer and Treasurer 32
EXHIBIT INDEX ------------- Exhibit No. Description of Document - -------------------------------------------------------------------------------- 10.1 Asset Purchase Agreement between SJWTX Water, Inc. and Canyon Lake Water Supply Corporation as of October 4, 2005. (1) 31.1 Certification Pursuant to Rule 13a-14(a)/15d-14(a) by President and Chief Executive Officer. (1) 31.2 Certification Pursuant to Rule 13a-14(a)/15d-14(a) by Chief Financial Officer and Treasurer. (1) 32.1 Certification Pursuant to 18 U.S.C. Section 1350 by President and Chief Executive Officer, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (1) 32.2 Certification Pursuant to 18 U.S.C. Section 1350 by Chief Financial Officer and Treasurer, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (1) (1) Filed currently herewith. 33