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| SJW > SEC Filings for SJW > Form 10-K on 9-Mar-2009 | All Recent SEC Filings |
9-Mar-2009
Annual Report
Description of Business
SJW Corp. is a publicly traded company and is a holding company with three subsidiaries:
San Jose Water Company, a wholly owned subsidiary, is a public utility in the business of providing water service to approximately 226,000 connections that serve a population of approximately one million people in an area comprising approximately 138 square miles in the metropolitan San Jose, California area. The United States water utility industry is largely fragmented and is dominated by municipal-owned water systems. The water industry is regulated, and provides a life-sustaining product. This makes water utilities subject to lower business cycle risks than nonregulated industries.
SJW Land Company, a wholly owned subsidiary, owns undeveloped land in the states of California and Tennessee, owns and operates commercial buildings in the states of California, Florida, Connecticut, Texas, Arizona and Tennessee and has a 70% limited partnership interest in 444 West Santa Clara Street, L.P.
SJWTX, Inc., doing business as Canyon Lake Water Service Company, a wholly owned subsidiary, was incorporated in September 2005. CLWSC provides service to approximately 8,700 connections that serve approximately 36,000 residents in a service area comprising more than 153 square miles in the growing region between San Antonio and Austin, Texas, as of December 31, 2008.
SJW Corp. also owns 1,099,952 shares or approximately 5% of California Water Service Group as of December 31, 2008.
On January 31, 2007, the rental equipment and existing inventory of Crystal Choice Water Service LLC, a 75% owned subsidiary engaged in the sale and rental of water conditioning and purification equipment, was sold for $635,000. Crystal Choice Water Service LLC was liquidated in August 2007.
Business Strategy
SJW Corp. focuses its business initiatives in four strategic areas:
(1) Regional regulated water utility operations.
(2) Regional nonregulated water utility related services provided in accordance with the guidelines established by the CPUC.
(3) Real estate 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 that provides water service to the greater metropolitan San Jose area, and CLWSC, a wholly owned regulated utility subsidiary in the State of Texas. SJW Corp. plans and applies a diligent and disciplined approach to maintaining and improving 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 capabilities and existing capacity by providing services to other regional water systems, benefiting its existing regional customers through increased efficiencies.
Real Estate Investment
SJW Land Company's real estate investments diversify SJW Corp.'s asset base and balances SJW Corp.'s concentration in regulated assets. SJW Land Company implements its real estate investment strategy by exchanging selected real estate assets for 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.
Out-of-Region Opportunities
SJW Corp. also from time to time pursues opportunities to participate in out-of-region water and utility related services, particularly regulated water businesses, in the Western United States. SJW Corp. evaluates out-of-region and out-of-state opportunities 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;
• potential profitability;
• additional growth opportunities within the region;
• water supply, water quality and environmental issues; and
• capital requirements.
SJW Corp. cannot be certain it will be successful in consummating any transactions relating to such opportunities. In addition, any transaction will involve numerous risks. Some of the risks include the possibility of paying more than the value derived from the acquisition, the assumption of certain known and unknown liabilities related to the acquired assets, the risk of diverting management's attention from normal daily operations of the business, the potential for a negative impact to SJW Corp.'s financial condition and operating results, the risks of entering markets in which SJW Corp. has 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 accounting policies delineated 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 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 are discussed in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" where such policies affect SJW Corp.'s reported and expected financial results. For a detailed discussion on the application of these and other accounting policies, see Note 1 of "Notes to Consolidated Financial Statements." SJW Corp.'s critical accounting policies are as follows:
Revenue Recognition
SJW Corp. recognizes its regulated and nonregulated revenue when services have been rendered, in accordance with SEC Staff Accounting Bulletin 104, "Revenue Recognition."
Metered revenue of the Water Utility Services 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. The Water Utility Services read the majority of its customers' meters on a bi-monthly basis and records its revenue based on its meter reading results. Unbilled revenue from the last meter reading date to the end of the accounting period is estimated based on the most recent usage patterns, production records and the effective tariff rates. Actual results could differ from those estimates, which would result in adjusting the operating revenue in the period which the revision to the Water Utility Services' estimates are determined. As of December 31, 2008 and 2007, accrued unbilled revenue was $12,896,000 and $12,654,000, respectively. Unaccounted for water for 2008 and 2007 approximated 7.4% and 7.2%, respectively, as a percentage of production. The estimate is based on the results of past experience, the trend and efforts in reducing the Water Utility Services' unaccounted-for water through customer conservation, main replacements and lost water reduction programs.
Revenues also include a surcharge collected from regulated customers that are paid to the CPUC. This surcharge is recorded in operating revenues and administrative and general expenses. For the years ended December 31, 2008, 2007 and 2006, the surcharge was $2,999,000, $2,708,000 and $2,505,000, 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 properties is generally recognized ratably over the term of the leases.
Recognition of Regulatory Assets and Liabilities
Generally-accepted accounting principles for water utilities include the recognition of regulatory assets and liabilities as permitted by Statement of Financial Accounting Standards (SFAS) No. 71, "Accounting for the Effects of Certain Types of Regulation." In accordance with SFAS No. 71, the Water Utility Services, to the extent applicable, record deferred costs and credits on the balance sheet as regulatory assets and liabilities when it is probable that these costs and credits will be recognized in the ratemaking process in a period different from when the costs and credits are incurred. Accounting for such costs and credits is based on management's judgment and prior historical ratemaking practices, and it occurs when management determines that it is probable that these costs and credits will be recognized in the future revenue of the Water Utility Services through the ratemaking process. The regulatory assets and liabilities recorded by the Water Utility Services, in particular, San Jose Water Company, primarily relate to the recognition of deferred income taxes for ratemaking versus tax accounting purposes and the postretirement pension benefits, medical costs, accrued benefits for vacation and asset retirement obligation that have not been passed through rates. The disallowance of any asset in future ratemaking, including deferred regulatory assets, would require San Jose Water Company to immediately recognize the impact of the costs for financial reporting purposes. No disallowance was recognized at December 31, 2008 and December 31, 2007. The net regulatory assets recorded by San Jose Water Company were $73,778,000 and $44,712,000 as of December 31, 2008 and 2007, respectively. As of December 31, 2006, San Jose Water Company has recorded its expected postretirement benefit plan liabilities and a corresponding regulatory asset relating to the implementation of the SFAS No. 158, "Employer's Accounting for Defined Benefit Pension and Other Postretirement Plans," including a reclassification of benefit obligations previously recorded to comprehensive income, in the amount of $3,666,000, resulting in an increase to regulatory assets of $38,410,000. The change in regulatory assets from 2006 to 2007 and 2007 to 2008 was primarily attributable to the funded status of pensions and other postretirement benefit plans based on the projected benefit obligations and the gross-up for taxes.
Pension Accounting
San Jose Water Company offers a defined benefit plan, an Executive Supplemental Retirement Plan and certain postretirement benefits other than pensions to employees retiring with a minimum level of service. Accounting for pensions and other postretirement benefits requires an extensive use of assumptions about the discount rate applied to expected benefit obligations, expected return on plan assets, the rate of future compensation increases received by the employees, mortality, turnover and medical costs. See assumptions and disclosures detailed in Note 10 of "Notes to Consolidated Financial Statements."
The Pension Plan is administered by a committee that is composed of an equal number of Company and Union representatives (the "Committee"). Investment decisions have been delegated by the Committee to an Investment Manager, presently Wachovia Securities, LLC. Investment guidelines provided to the Investment Manager require that at least 25% of plan assets be invested in bonds or cash. As of December 31, 2008, the plan assets consist of approximately 45% bonds, 3% cash and 52% equities. Furthermore, equities are to be diversified by industry groups and selected to achieve preservation of capital coupled with long-term growth through capital appreciation and income. They may not invest in commodities and futures contracts, private placements, options, letter stock, speculative securities, or hold more than 5% of assets of any one private corporation. They may only invest in bonds, commercial paper, and money market funds with acceptable ratings by Moody's or Standard & Poor's. The Investment Manager is reviewed regularly regarding performance by the Investment Consultant who provides quarterly reports to the Committee for review.
The market values of the plan assets are marked to market at the measurement date. The investment trust assets incur unrealized market gains or losses from time to time. As a result the pension expense in 2008 included the amortization of unrealized market losses on pension assets. Both unrealized market gains and losses on pension assets are amortized over 13.25 years for actuarial expense calculation purposes. Market losses in 2007 increased pension expense by approximately $142,000 in 2008 and market gains in 2006 decreased pension expense by approximately $223,000 in 2007.
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 regulatory environment. These differences result in deferred tax assets and liabilities, which are included on the balance sheet. If actual results, due to changes in the 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.
Balancing Account
Pursuant to Section 792.5 of the California Public Utilities Code, a balancing account must be maintained for each expense item for which revenue offsets have been authorized. The purpose of a balancing account is to track the under-collection or over-collection associated with expense changes and the revenue authorized by CPUC to offset those expense changes.
A separate balancing account must be maintained for each offset expense item (e.g., purchased water, purchased power and groundwater extraction charges). The balancing account balance 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 account tends to reflect an under-collection while, during the winter months when demand for water is relatively lower, the account tends to reflect an over-collection. Since the balances have to be approved by the CPUC before they can be incorporated into rates, San Jose Water Company does not recognize the balancing account in its revenue until the CPUC authorizes the change in customers' rates. However, 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 the account over-collection or increased by the amount of the account under-collection, less applicable taxes. Please also see Item 1A, "Risk Factors."
As of December 31, 2008 and 2007, the total accrued balance in San Jose Water Company's balancing account was an over-collection of $1,977,000 and $1,656,000, respectively, including interest. All balancing accounts will be reviewed by the CPUC in San Jose Water Company's next general rate case.
Recognition of Gain/Loss on Utility, Nonutility Property and Real Estate Investments
In conformance with 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.
Utility property in the Water Utility Services is property that is used and useful in providing water utility services to customers and is included in rate base for rate-setting purposes. In California, real estate type utility property is subject to CPUC Code Section 851, which states any gain recognized will be divided with two-thirds going to the customers and one-third to the shareholders. Net gains or losses from the sale of utility property are recorded as a component of other (expense) income in the consolidated statement of income and comprehensive income.
Nonutility property in the Water Utility Services 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.
SJW Land Company owns real estate investment property, which consists primarily of land and buildings. Net gains and losses from the sale of real estate investments are recorded as a component of other (expense) income in the consolidated statement of income and comprehensive income.
Results of Operations
SJW Corp.'s consolidated net income for the 12 months ending December 31, 2008 was $21,461,000, compared to $19,323,000 for the same period in 2007. The increase of $2,138,000 or 11% includes an after tax gain of $1,224,000 from the sale of Water Utility Services properties in 2008. Please refer to Note 12, "Sale of Real Estate Investments" under Notes to Consolidated Financial Statements.
SJW Land Company and its consolidated variable interest entity, 444 West Santa Clara Street, L.P., which operates commercial building rentals, are collectively referred to as "Real Estate Services."
Operating Revenue
Operating revenue by segment was as follows:
Operating Revenue
2008 2007 2006
(in thousands)
Water Utility Services $ 213,801 200,004 183,809
Real Estate Services 6,546 6,486 4,317
All Other - 111 1,112
$ 220,347 206,601 189,238
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Operating revenue increased $13,746,000 or 7% in 2008 compared to 2007, and $17,363,000 or 9% in 2007 compared to 2006.
The change in consolidated operating revenue was due to the following factors:
2008 vs. 2007 2007 vs. 2006
Increase/(decrease) Increase/(decrease)
(in thousands)
Water Utility Services:
Consumption changes $ (735 ) - $ 2,784 1 %
New customers increase 574 - 3,002 2 %
Rate increases 13,958 7 % 10,409 5 %
Real Estate Services 60 - 2,169 1 %
All Other (111 ) - (1,001 ) -
$ 13,746 7 % $ 17,363 9 %
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2008 vs. 2007
Consolidated operating revenue increased by $13,746,000 in 2008 or 7% in comparison to 2007. The revenue increase consists of $13,797,000 from Water Utility Services and $60,000 from Real Estate Services. The revenue increases were offset by an $111,000 decrease in other revenues primarily due to the sale of the assets of Crystal Choice Water Service LLC on January 31, 2007.
The revenue increase for the Water Utility Services was primarily the result of increases in rates of $13,958,000 and new customers of $574,000 which was offset by a decrease in consumption of $735,000.
As noted in Item 1A, "Risk Factors", the tenant of the buildings in Tennessee filed Chapter 11 bankruptcy. The tenant will have a limited period of time to decide whether it will terminate its leases or sell its rights under the leases. In the event the leases are terminated and a new tenant is not identified, Real Estate Services revenue for 2009 would be approximately $3,300,000 less than what was recognized in 2008. Further, if the buildings are vacant, Real Estate Services expects to incur holding costs for taxes, insurance, utilities and other miscellaneous expenses.
2007 vs. 2006
Consolidated operating revenue increased by $17,363,000 in 2007 or 9% in comparison to 2006. The revenue increase consists of $16,195,000 from Water Utility Services and $2,169,000 from Real Estate Services. The revenue increases were offset by a $1,001,000 decrease in other revenues primarily due to the sale of the assets of Crystal Choice Water Service LLC on January 31, 2007.
The revenue increase for the Water Utility Services was primarily the result of increases in rates, consumption, customers and a full year of operation at CLWSC. The increase in SJW Land Company was primarily due to a $3,122,000 increase in rental income from the Tennessee warehouse and commercial property acquired in February 2007 and $404,000 is attributable to a full year of rental income from the Arizona warehouse property acquired in June 2006. The SJW Land Company revenue increases were offset by a $1,357,000 decrease in parking and rental revenue as a result of the sale of parking facilities in December 2006.
Water Utility Services Operating Revenue and Customer Counts
The following tables present operating revenues and number of customers by customer group of the Water Utility Services:
Operating Revenue by Customer Group
2008 2007 2006
(in thousands)
Residential and business $ 195,901 182,917 169,251
Industrial 1,067 1,287 1,115
Public authorities 11,227 10,469 8,903
Others 5,606 5,331 4,540
$ 213,801 200,004 183,809
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Number of Customers
2008 2007 2006
Residential and business 228,794 227,789 226,332
Industrial 77 79 83
Public authorities 1,591 1,715 1,725
Others 3,838 3,717 3,560
234,300 233,300 231,700
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Operating Expense
Operating expense by segment was as follows:
Operating Expense
2008 2007 2006
(in thousands)
Water Utility Services $ 183,774 172,698 153,199
Real Estate Services 2,995 2,994 2,403
All Other 684 1,156 2,083
$ 187,453 176,848 157,685
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Operating expense increased $10,605,000 or 6% in 2008 compared to 2007, and $19,163,000 or 12% in 2007 compared to 2006.
The change in operating expense was due to the following:
2008 vs. 2007 2007 vs. 2006
Increase/(decrease) Increase/(decrease)
(in thousands)
Water Production Costs:
Change in surface water supply $ (2,090 ) (1 )% $ 8,685 6 %
Change in usage and new customers (8 ) - 3,967 2 %
Purchased water and groundwater
extraction charge and energy price
increase 6,047 3 % 4,814 3 %
Total water production costs 3,949 2 % 17,466 11 %
Administrative and general 1,354 1 % 1,226 1 %
Other operating expense 1,483 1 % (188 ) -
Maintenance 1,495 1 % 1,439 1 %
Property taxes and other non-income
taxes 486 - 414 -
Depreciation and amortization 1,189 1 % 1,555 1 %
Income taxes 649 - (2,749 ) (2 )%
$ 10,605 6 % $ 19,163 12 %
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The various components of operating expenses are discussed below.
Water production costs
2008 vs. 2007
Water production costs increased $3,949,000 primarily due to $6,047,000 in purchased water and groundwater extraction charge price increases, offset by $2,090,000 in decreased surface water supply costs due to increased availability of surface water supply in 2008 compared to 2007.
2007 vs. 2006
The lack of precipitation in 2007 adversely impacted the Water Utility Services' operating results. Water production costs increased $17,466,000 primarily due to a decreased surface water supply necessitating $8,685,000 in additional purchased water, $4,393,000 in purchased water unit price increases and additional groundwater extraction charges and $3,967,000 due to increased usage by customers and new customers.
Sources of Water Supply The Water Utility Services water supply consists of groundwater from wells, surface water from watershed run-off and diversion, reclaimed water and water purchased from regional wholesalers. Surface water is the least expensive source of water. The following table presents the sources of water supply for the Water Utility Services: . . . |
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