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SJW > SEC Filings for SJW > Form 10-Q on 31-Oct-2012All Recent SEC Filings

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Form 10-Q for SJW CORP


31-Oct-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

(Dollar amounts in thousands, except where otherwise noted and per share amounts) The information in this Item 2 should be read in conjunction with the financial information and the notes thereto included in Item 1 of this Form 10-Q and the consolidated financial statements and notes thereto and the related "Management's Discussion and Analysis of Financial Condition and Results of Operations" contained in SJW Corp.'s Annual Report on Form 10-K for the year ended December 31, 2011.
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 its subsidiaries and the industries in which SJW Corp. and its subsidiaries operate and the beliefs and assumptions of the management of SJW Corp. Such forward-looking statements are identified by words including "expect," "estimate," "anticipate," "intends," "seeks," "plans," "projects," "may," "should," "will," and variation of such words, and similar expressions. These forward-looking statements are only predictions and are subject to risks, uncertainties and assumptions that are difficult to predict. Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements. Important factors that could cause or contribute to such differences include, but are not limited to, those discussed in this report and our most recent Form 10-K filed with the SEC under the item entitled "Risk Factors," and in other reports SJW Corp. files with the SEC, specifically the most recent reports on Form 10-Q and Form 8-K, each as it may be amended from time to time. SJW Corp. undertakes no obligation to update or revise the information contained in this report, including the forward-looking statements, to reflect any event or circumstance that may arise after the date of this report.

General:
SJW Corp. is a holding company with four subsidiaries: San Jose Water Company, SJW Land Company, SJWTX, Inc., and Texas Water Alliance Limited. San Jose Water Company, a wholly owned subsidiary of SJW Corp., is a public utility in the business of providing water service to approximately 227,000 connections that serve a population of approximately one million people in an area comprising approximately 138 square miles in the metropolitan San Jose, California area.
The principal business of San Jose Water Company consists of the production, purchase, storage, purification, distribution, wholesale and retail sale of water. San Jose Water Company provides water service to customers in portions of the cities of Cupertino and San Jose and in the cities of Campbell, Monte Sereno, Saratoga and the Town of Los Gatos, and adjacent unincorporated territories, all in the County of Santa Clara in the State of California. San Jose Water Company distributes water to customers in accordance with accepted water utility methods which include pumping from storage and gravity feed from high elevation reservoirs. San Jose Water Company also provides non-tariffed services under agreements with municipalities and other utilities. These non-tariffed services include water system operations, maintenance agreements and antenna leases.
San Jose Water Company has utility property including land held in fee, impounding reservoirs, diversion facilities, wells, distribution storage, and all water facilities, equipment, office buildings and other property necessary to supply its customers. Under Section 851 of the California Public Utilities Code, properties currently used and useful in providing utilities services cannot be disposed of unless CPUC approval is obtained.
San Jose Water Company also has approximately 700 acres of nonutility property which has been identified as no longer used and useful in providing utility services. The majority of the properties are located in the hillside area adjacent to San Jose Water Company's various watershed properties.


SJW Land Company, a wholly owned subsidiary of SJW Corp., owned the following real properties during the quarter ended September 30, 2012:

                                                                                 % for Nine Months Ended
                                                                                    September 30, 2012
                                                                                   of SJW Land Company
      Description               Location         Acreage    Square Footage     Revenue            Expense
2 Commercial buildings    San Jose, California          2           28,000         14 %              13  %
Warehouse building        Windsor, Connecticut         17          170,000         16 %              15  %
Warehouse building *      Orlando, Florida              8          147,000          7 %             (23 )%
Retail building           El Paso, Texas                2           14,000          6 %               3  %
Warehouse building        Phoenix, Arizona             11          176,000         17 %              14  %
Warehouse building        Knoxville, Tennessee         30          361,500        N/A                18  %
Commercial building       Knoxville, Tennessee         15          135,000         40 %              60  %
Undeveloped land          Knoxville, Tennessee         10              N/A        N/A               N/A
Undeveloped land          San Jose, California          5              N/A        N/A               N/A

* On August 8, 2012, SJW Land Company closed on the sale of its Florida warehouse building. Revenue and expense amounts are through the sale closing date. Expense amount is net of the gain on sale of property.

On August 14, 2012, SJW Land Company entered into a lease with a single tenant for approximately 50,000 square feet of office space and approximately 25,000 square feet of space in the distribution facility of the Company's properties located in Knoxville, Tennessee. The lease commences on or about July 1, 2013 and is a modified full service lease with an initial fifteen-year term and four five-year term options.
On October 16, 2012, SJW Land Company entered into a lease agreement for approximately 326,000 square feet of the distribution facility located in Knoxville, Tennessee. The lease commences on or about November 1, 2012 and is a modified net lease with an initial five-year and four-month term and two three-year options.
SJW Land Company owns a 70% limited partnership interest in 444 West Santa Clara Street, L.P. One of the California properties is owned by such partnership. The limited partnership has been determined to be a variable interest entity within the scope of FASB ASC Topic 810 - "Consolidation" with SJW Land Company as the primary beneficiary, and as a result, it has been consolidated with SJW Land Company.
SJWTX, Inc., a wholly owned subsidiary of SJW Corp., doing business as Canyon Lake Water Service Company ("CLWSC"), is a public utility in the business of providing water service to approximately 10,000 connections that serve approximately 36,000 people. CLWSC's service area comprises more than 240 square miles in western Comal County and southern Blanco County in the growing region between San Antonio and Austin, Texas. SJWTX, Inc. has a 25% interest in Acequia Water Supply Corporation ("Acequia"). The water supply corporation has been determined to be a variable interest entity within the scope of ASC Topic 810 with SJWTX, Inc. as the primary beneficiary. As a result, Acequia has been consolidated with SJWTX, Inc.
Texas Water Alliance Limited ("TWA"), a wholly owned subsidiary of SJW Corp., is undertaking activities that are necessary to develop a water supply project in Texas.

Business Strategy:
SJW Corp. focuses its business initiatives in three 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 in California and the Texas Commission on Environmental Quality ("TCEQ") in Texas.

(3) Out-of-region water and utility related services, primarily in the Western United States.

As part of its pursuit of the above three strategic areas, the Company considers from time to time opportunities to acquire businesses and assets. However, SJW Corp. cannot be certain it will be successful in identifying and consummating any strategic business acquisitions relating to such opportunities. In addition, any transaction will involve numerous risks, including the possibility of incurring more costs than benefits derived from the acquisition, the assumption of certain known and


unknown liabilities related to the acquired assets, the diversion of management's attention from day-to-day operations of the business, the potential for a negative impact on SJW Corp.'s financial position and operating results, 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. SJW Corp.'s real estate investment activity is conducted through SJW Land Company. SJW Land Company owns undeveloped land and owns and operates a portfolio of commercial buildings in the states of California, Connecticut, Texas, Arizona and Tennessee. SJW Land Company also owns a limited partnership interest in 444 West Santa Clara Street, L.P. The partnership owns a commercial building in San Jose, California. SJW Land Company implements its investment strategy by managing our asset portfolio to generate cash for corporate initiatives. SJW Land Company's real estate investments diversify SJW Corp.'s asset base.

Critical Accounting Policies:
SJW Corp. has identified the 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 consolidated 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. 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 FASB ASC Topic 605 - "Revenue Recognition."

Metered revenue of 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. 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 may result in an adjustment to the operating revenue in the period which the revision to Water Utility Services' estimates is determined.
Revenues also include a surcharge collected from regulated customers that is paid to the CPUC. This surcharge is recorded both in operating revenues and administrative and general expenses. For the nine months ended September 30, 2012 and 2011, the surcharge was $2,919 and $2,373, 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, maintenance agreements or antenna leases 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 FASB ASC Topic
980 - "Regulated Operations." In accordance with ASC Topic 980, Water Utility Services, to the extent applicable, 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 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 Water Utility Services through the ratemaking process. The regulatory assets and liabilities recorded by 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 obligations that have not been passed through in rates. The Company adjusts the related asset and liabilities for these items through its regulatory asset and liability accounts at year-end. 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 during the quarter ended September 30, 2012 or during the year ended December 31, 2011.


Pension Plan Accounting
San Jose Water Company offers a Pension 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 the use of assumptions about the discount rate applied to expected benefit obligations, expected return on plan assets, the rate of future compensation increases expected to be received by the employees, mortality, turnover, and medical costs. Plan assets are marked to market at each measurement date.
Income Taxes
SJW Corp. estimates its federal and state income taxes as part of the process of preparing consolidated 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 and Memorandum Accounts
The purpose of a balancing account is to track the under-collection or over-collection associated with expense changes and the revenue authorized by the CPUC to offset those expense changes. Pursuant to Section 792.5 of the California Public Utilities Code, a balancing account must be maintained for expense items for which revenue offsets have been authorized.
Balancing accounts are currently being maintained for the following items:
purchased water, purchased power, groundwater extraction charges, and pensions. The amount in the water supply balancing accounts vary with the seasonality of the water utility business such that, during the summer months when the demand for water is at its peak, the accounts tend to reflect an under-collection, while during the winter months when demand for water is relatively lower, the accounts tend to reflect an over-collection. The pension balancing account is intended to capture the difference between actual pension expense and the amount approved in rates by the CPUC.
Since the amounts in the balancing accounts must be approved by the CPUC before they can be incorporated into rates, San Jose Water Company does not recognize balancing accounts in its revenue until CPUC approval occurs. It is typical for the CPUC to incorporate any over-collected and/or under-collected balances in balancing accounts into customer rates at the time rate decisions are made as part of the Company's general rate case proceedings by assessing temporary surcredits and/or surcharges.
San Jose Water Company also maintains memorandum accounts to track revenue impacts due to catastrophic events, certain unforeseen water quality expenses related to new federal and state water quality standards, energy efficiency, any revenue requirement impact of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, and other approved activities or as directed by the CPUC. Rate recovery for these memorandum accounts is generally allowed in the next general rate cases.
In the case where the Company's balancing or memorandum-type accounts that have been authorized by the CPUC reach certain thresholds or have termination dates, the Company can request the CPUC to recognize the amounts in such accounts in customer rates prior to the next regular general rate case proceeding by filing an advice letter. If such amounts are authorized for inclusion into customer rates, revenue would be recognized at the time authorization is received pursuant to ASC Topic 605 and Sub-topic 980-605.
If the balancing or memorandum-type accounts had been recognized in San Jose Water Company's financial statements, San Jose Water Company's earnings and retained earnings would be decreased by the amount of surcredits in the case of over-collection or increased by the surcharges in the case of under-collection, less applicable taxes.

Recent Accounting Pronouncements:
In July 2012, the FASB issued an accounting standard update ("ASU") that permits an entity to make a qualitative assessment to determine whether it is more likely than not that an indefinite-lived intangible asset, other than goodwill, is impaired. Entities are required to test indefinite-lived intangible assets for impairment at least annually and more frequently if indicators of impairment exist. If an entity concludes, based on an evaluation of all relevant qualitative factors, that it is not more likely than not that the fair value of an indefinite-lived intangible asset is less than its carrying amount, it is not required to perform the quantitative impairment test for that asset. Since the qualitative assessment is optional, an entity is permitted to bypass it for any indefinite-lived intangible asset in any period and apply the quantitative test. The ASU also permits the entity to resume performing the qualitative assessment in any subsequent period. The ASU becomes effective for annual and interim impairment tests performed for the Company's fiscal year ending December 31, 2012, and early adoption is permitted.


Results of Operations:
Water sales are seasonal in nature and influenced by weather conditions. The timing of precipitation and climatic conditions can cause seasonal water consumption by customers to vary significantly. Due to the seasonal nature of the water business, the operating results for interim periods are not indicative of the operating results for a 12-month period. Revenue is generally higher in the warm, dry summer months when water usage and sales are greater and lower in the winter months when cooler temperatures and increased rainfall curtail water usage and sales.
Overview
SJW Corp.'s consolidated net income for the three months ended September 30, 2012 was $10,084, an increase of $1,869 or approximately 23%, from $8,215 in the third quarter of 2011. The increase in net income was primarily due to an increase in usage and rates offset in part by higher water production costs, administrative and general expenses and depreciation. For the nine months ended September 30, 2012, consolidated net income was $16,394, an increase of $2,118, or 15%, from $14,276 for the same period in 2011. The increase in net income was primarily due to an increase in usage and rates, offset in part by higher per unit costs for purchased water, administrative and general expenses and depreciation.

Operating Revenue

                                                        Operating Revenue by Segment
                                                Three months ended          Nine months ended
                                                  September 30,               September 30,
                                                2012           2011          2012         2011
Water Utility Services                      $    81,188       72,717     $  195,410     173,234
Real Estate Services                              1,186        1,197          3,688       3,383
                                            $    82,374       73,914     $  199,098     176,617

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

                           Three months ended           Nine months ended
                             September 30,                September 30,
                             2012 vs. 2011                2012 vs. 2011
                          Increase/(decrease)          Increase/(decrease)
Water Utility Services:
Consumption changes     $       1,781        2 %   $       7,644           4 %
New customers increase            406        1 %             907           1 %
Rate increases                  6,284        8 %          13,625           8 %
Real Estate Services              (11 )      - %             305           - %

$ 8,460 11 % $ 22,481 13 %

Operating Expense
                                                        Operating Expense by Segment
                                                Three months ended          Nine months ended
                                                  September 30,               September 30,
                                                2012           2011          2012         2011
Water Utility Services                      $    60,472       54,043     $  154,726     134,694
Real Estate Services                                805          844          2,478       2,493
All Other                                           220          541            707       1,559
                                            $    61,497       55,428     $  157,911     138,746


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

                                                Three months ended                  Nine months ended
                                                  September 30,                       September 30,
                                                  2012 vs. 2011                       2012 vs. 2011
                                               Increase/(decrease)                 Increase/(decrease)
Water production costs:
Change in surface water supply          $      1,692                   2 %   $         5,211             4 %
Change in usage and new customers                328                   1 %             3,757             2 %
Purchased water and groundwater
extraction charge and energy price
increase                                       2,593                   5 %             5,451             4 %
Total water production costs                   4,613                   8 %            14,419            10 %
Administrative and general                       891                   2 %             2,891             2 %
Maintenance                                       80                   - %              (322 )           - %
Property taxes and other non-income
taxes                                              -                   - %               644             1 %
Depreciation and amortization                    485                   1 %             1,533             1 %
                                        $      6,069                  11 %   $        19,165            14 %

Sources of Water Supply
San Jose Water Company's water supply consists of surface water from watershed run-off and diversion, reclaimed water, and imported water and groundwater from wells purchased from the Santa Clara Valley Water District ("SCVWD") under the terms of a master contract with SCVWD expiring in 2051. Changes and variations in quantities from each of these sources affect the overall mix of the water supply, thereby affecting the cost of the water supply. In addition, the water rate for purchased water and groundwater may be increased by the SCVWD at any time. If an increase occurs, then San Jose Water Company would file an advice letter with the CPUC seeking authorization to increase revenues to offset the cost increase.
CLWSC's water supply consists of groundwater from wells and purchased raw water from the Guadalupe-Blanco River Authority ("GBRA"). CLWSC has long-term agreements with GBRA, which expire in 2040, 2044 and 2050. The agreements, which are take-or-pay contracts, provide CLWSC with 6,700 acre-feet of water per year from Canyon Lake and other sources at prices to be adjusted periodically by GBRA.
Surface water is the least expensive source of water. The following table presents the change in sources of water supply, in million gallons, for Water Utility Services:

                 Three months ended                                  Nine months ended
                    September 30,        Increase/                     September 30,       Increase/
                  2012        2011      (decrease)     % Change       2012       2011     (decrease)     % Change
Purchased water  10,359       9,452          907           6  %     25,846     20,031         5,815         16  %
Groundwater       4,690       4,644           46           -  %      9,751     11,003        (1,252 )       (3 )%
Surface water       653       1,442         (789 )        (5 )%      1,833      4,425        (2,592 )       (7 )%
Reclaimed water     231         217           14           -  %        445        324           121          -  %
                 15,933      15,755          178           1  %     37,875     35,783         2,092          6  %

The changes in the source of supply mix were consistent with the changes in the water production costs.
Unaccounted-for water on a 12 month-to-date basis for September 30, 2012 and 2011 approximated 5.8% and 7.8%, respectively, as a percentage of total production. The estimate is based on the results of past experience, the trend and efforts in reducing Water Utility Services' unaccounted-for water through main replacements and lost water reduction programs. Water production costs
For the three and nine months ended September 30, 2012 compared to the same periods in 2011, the increase in water production costs was primarily attributable to higher customer water usage and higher per unit costs for purchased water and groundwater extraction charges. Effective July 2012, SCVWD increased the unit price of purchased water by approximately 8% and the groundwater extraction charge by approximately 9%. In addition, production costs . . .

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