10-Q 1 sjw10q2004-2.txt SJW CORP 10Q 2004 - 2ND QTR UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended June 30, 2004 ---------------------------------------------------------------- Commission file number 1-8966 ---------------------------------------------------------------- SJW Corp. ---------------------------------------------------------------- (Exact name of registrant as specified in its charter) California 77-0066628 ---------------------------------------------------------------- (State or other jurisdiction of (I.R.S Employer incorporation or organization) Identification No.) 374 West Santa Clara Street, San Jose, CA 95196 ---------------------------------------------------------------- (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 the date of this report are 9,138,841. 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 SIX MONTHS ENDED JUNE 30 ENDED JUNE 30 2004 2003 2004 2003 (Restated (Restated see Note 3) see Note 3) -------------------------------------- OPERATING REVENUE $45,609 38,149 $76,672 66,120 OPERATING EXPENSES Operation: Purchased water 11,666 8,873 18,176 14,920 Power 1,597 1,376 2,411 2,113 Pump taxes 5,902 4,201 9,023 6,269 Administrative and general 4,484 4,183 8,794 7,953 Other 3,287 3,205 6,536 6,291 Maintenance 2,179 1,903 4,287 3,676 Property taxes and other nonincome taxes 1,325 1,222 2,654 2,491 Depreciation and Amortization 4,707 3,825 9,100 7,565 Income taxes 3,352 3,053 4,596 4,472 -------------------------------------- Total operating expenses 38,499 31,841 65,577 55,750 -------------------------------------- OPERATING INCOME 7,110 6,308 11,095 10,370 Gain on sale of nonutility property, net of income taxes of $2,105 - - - 3,030 Interest on long-term debt (2,382) (2,106) (4,764) (4,192) Dividend income 310 310 621 619 Other, net (231) (86) (371) (119) -------------------------------------- NET INCOME $ 4,807 4,426 $ 6,581 9,708 ====================================== Other comprehensive income (loss): Unrealized income (loss) on investment (815) 2,606 164 4,916 Income taxes 334 (1,068) (67) (2,015) --------------------------------------- Other comprehensive income loss), net (481) 1,538 97 2,901 --------------------------------------- COMPREHENSIVE INCOME $ 4,326 5,964 $ 6,678 12,609 ======================================= EARNINGS PER SHARE Basic $ 0.53 0.48 $ 0.72 1.06 Diluted $ 0.53 0.48 $ 0.72 1.06 ======================================= COMPREHENSIVE INCOME PER SHARE Basic $ 0.47 0.65 $ 0.73 1.38 Diluted $ 0.47 0.65 $ 0.73 1.38 ====================================== DIVIDENDS PER SHARE $ 0.26 0.25 $ 0.51 0.49 ====================================== WEIGHTED AVERAGE SHARES OUTSTANDING Basic 9,138,841 9,135,441 9,136,758 9,135,441 Diluted 9,193,895 9,135,441 9,191,077 9,135,441 See accompanying Notes to Unaudited Condensed Consolidated Financial Statements. SJW CORP. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) (In thousands) JUNE 30 DECEMBER 31 2004 2003 (Restated see Note 3) ASSETS ------------------------ UTILITY PLANT: Land $ 1,735 $ 1,750 Depreciable plant and equipment 585,932 570,119 Construction in progress 8,070 4,000 Intangible assets 7,840 7,840 ------------------------ Total utility plant 603,577 583,709 Less accumulated depreciation and amortization 184,074 174,985 ------------------------ Net utility plant 419,503 408,724 NONUTILITY PROPERTY 35,313 34,918 Less accumulated depreciation 2,818 2,349 ------------------------ Net nonutility property 32,495 32,569 CURRENT ASSETS: Cash and equivalents 5,270 10,278 Accounts receivable and accrued unbilled utility revenue 22,492 15,043 Prepaid expenses and other 1,918 2,019 ------------------------ Total current assets 29,680 27,340 OTHER ASSETS: Investment in California Water Service Group 30,304 30,139 Unamortized debt issuance and reacquisition costs 3,372 3,447 Regulatory assets 8,337 7,976 Other 5,787 6,049 ---------------------- Total other assets 47,800 47,611 ---------------------- $529,478 $516,244 ====================== CAPITALIZATION AND LIABILITIES CAPITALIZATION: Common stock $ 9,520 $ 9,516 Additional paid-in capital 13,846 13,375 Retained earnings 140,040 138,058 Accumulated other comprehensive income 5,516 5,419 ---------------------- Total shareholders' equity 168,922 166,368 Long-term debt, less current portion 143,917 143,947 ---------------------- Total capitalization 312,839 310,315 CURRENT LIABILITIES: Current portion of long-term debt 93 184 Accrued pump taxes and purchased water 6,672 3,224 Purchased power 1,462 864 Accounts payable 5,368 2,217 Accrued interest 3,619 3,619 Accrued taxes 2,092 467 Other current liabilities 4,501 4,501 ---------------------- Total current liabilities 23,807 15,076 DEFERRED INCOME TAXES 40,767 38,207 ADVANCES FOR AND CONSTRIBUTIONS IN AID OF CONSTRUCTION 141,567 141,122 OTHER NONCURRENT LIABILITIES 10,498 11,524 ---------------------- $529,478 $516,244 ====================== See accompanying Notes to Unaudited Condensed Consolidated Financial Statements. SJW CORP. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (In thousands) SIX MONTHS ENDED JUNE 30 2004 2003 (Restated see note 3) ---------------------- OPERATING ACTIVITIES: Net income $ 6,581 $ 9,708 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 9,100 7,565 Deferred income taxes 2,560 4,561 Stock-based compensation 581 18 Gain on sale of nonutility property, net of taxes - (3,030) Changes in operating assets and liabilities: Accounts receivable and accrued unbilled utility revenue (7,449) (4,308) Accounts payable, purchased power and other current liabilities 3,749 5,538 Accrued pump taxes and purchased water 3,448 3,089 Accrued taxes 1,625 2,490 Other noncurrent assets and noncurrent liabilities (1,438) (1,466) Other changes, net 624 5 --------------------- NET CASH PROVIDED BY OPERATING ACTIVITIES 19,381 24,170 --------------------- INVESTING ACTIVITIES: Additions to utility plant (20,538) (22,260) Additions to nonutility property (265) (15,612) Cost to retire utility plant, net of salvage (158) (260) Proceeds from sale of nonutility property - 5,370 --------------------- NET CASH USED IN INVESTING ACTIVITIES (20,961) (32,762) --------------------- FINANCING ACTIVITIES: Repayments for line of credit, net of borrowings - (5,150) Long-term borrowings, net of repayments (121) 9,852 Stock issuance and buyback (33) - Dividends paid (4,599) (4,429) Receipts of advances and contributions in aid of construction 2,262 8,594 Refunds of advances for construction (937) (751) ---------------------- NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES (3,428) 8,116 ---------------------- NET CHANGE IN CASH AND EQUIVALENTS (5,008) (476) ---------------------- CASH AND EQUIVALENTS, BEGINNING OF PERIOD 10,278 581 ---------------------- CASH AND EQUIVALENTS, END OF PERIOD $ 5,270 $ 105 ---------------------- Cash paid during the period for: Interest $ 5,084 $ 4,244 Income taxes (14) 650 See accompanying Notes to Unaudited Condensed Consolidated Financial Statements. SJW CORP. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 2004 Note 1. General ---------------- In the opinion of SJW Corp. (the Corporation), 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 2003 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 twelve-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 income per share are based upon the weighted average number of common shares including both shares outstanding and shares potentially issued in connection with stock options and restricted common stock units granted under SJW Corp. Long Term Incentive Plan, and income available to common shareholders and comprehensive income, respectively, adjusted for recognized stock compensation expense. For the three months ended June 30, 2004 and 2003, the basic weighted average number of common shares was 9,138,841 and 9,135,441, respectively. For the six months ended June 30, 2004 and 2003, the basic weighted average number of common shares was 9,136,758 and 9,135,441, respectively. For the three and six month periods ended June 30, 2004, the diluted weighted average number of common shares outstanding was 9,193,895 and 9,191,077, respectively. The diluted weighted average number of common shares was 9,135,441 for both three and six month periods ending June 30, 2003. There were no common stock equivalents during the three and six-month periods ended June 30, 2003. On January 29, 2004, the Board of Directors of SJW Corp. approved a three-for-one stock split of common stock. The three-for-one stock split was effective on March 2, 2004. Basic and diluted earnings and comprehensive income per share in the current and prior periods reflect the impact of stock split. Note 2. Long-Term Incentive Plan --------------------------------- The Corporation has reserved 900,000 common shares for issuance under the Long-Term Incentive Plan (Incentive Plan). As of June 30, 2004, 4,295 shares have been issued pursuant to the Incentive Plan, and 154,189 shares are issuable upon the exercise of outstanding options and deferred restricted stock. The remaining shares available for issuance under the Incentive Plan are 741,516. The total compensation cost charged to income under the Incentive Plan was $290,000 and $581,000 for the three and six months ended June 30, 2004, respectively. The total benefit, including non-employee directors' converted post-retirement benefits, recorded in shareholders' equity under the Incentive Plan was $556,000, and $26,000 related to dividend equivalent units was accrued as a liability as of June 30, 2004. The Corporation 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 include: expected dividend yield of 3.4%, expected volatility of 27%, risk-free interest rate of 2.86%, expected holding period of five years. Stock Options Awards in the form of stock option agreements under the Incentive Plan allow executives to purchase common shares at a specified price. In January 2004, options to purchase 26,076 common shares at an exercise price of $29.70 per share were issued, and the weighted average fair value was $5.33 per share, at the date of grant. As of June 30, 2004, options to purchase 55,183 common shares were issued and 266 common shares were issued upon exercise of options. Shares subject to outstanding options under the Incentive Plan were 54,919. For the three and six months ended June 30, 2004, the Corporation has recognized stock compensation expense of $32,000 and $65,000, respectively, for the stock options granted to its executives. Deferred Restricted Stock Plans As of June 30, 2004, restricted stock units for 41,670 shares have been granted to a key employee of the Corporation. For the three and six months ended June 30, 2004, the Corporation has recognized stock compensation expense of $128,000 and $256,000, respectively, related to these restricted stock units. As of June 30, 2004, restricted stock units for 55,524 shares have been granted to non-employee Board members who elected to receive their existing and future cash pension benefits in restricted stock units under the Deferred Restricted Stock Program. As of June 30, 2004, 4,029 shares were issued pursuant to restricted stock units to a retired non-employee Board member. In accordance with SFAS No. 123, "Accounting for Stock-Based Compensation", the Corporation has recognized stock compensation expense of $102,000 and $204,000 for the three and six months ended June 30, 2004, respectively, related to restricted stock units under the Deferred Restricted Stock Program. In January 2004, 3,636 shares were issued at an exercise price of $29.75 per share, to the non-employee Board members who elected to convert their annual retainer fee in restricted stock units under the Deferred Restricted Stock Program. As of June 30, 2004, the Corporation has granted restricted stock units for 4,920 shares in lieu of cash retainer fees. For the three and six months ended June 30, 2004, the Corporation has recognized stock compensation expense of $29,000 and $57,000, respectively, related to restricted stock units issued to non-employee Board members in connection with their annual retainers. Dividend Equivalent Rights SJW Corp. also has a Dividend Equivalent Rights Agreement providing holders of options and restricted stock units to receive dividend rights each time a dividend is paid on common shares after the grant date. Stock compensation expenses is measured and recognized on dividend equivalent rights on the date they are granted. The above reported stock compensation expenses on stock options and restricted stock units includes the stock compensation expenses recognized on the dividend equivalent rights. Note 3. Partnership Interest Restatement ----------------------------------------- In January 2004, SJW Corp. adopted Interpretation No. 46(R), "Consolidation of Variable Interest Entities" issued by the Financial Accounting Standards Board (FASB). This interpretation provides guidance for determining when a primary beneficiary should consolidate a variable interest entity or equivalent structure, that functions to support the activities of the primary beneficiary. SJW Land Company, a wholly owned subsidiary of SJW Corp., owns a 70% limited partnership interest in 444 West Santa Clara Street, L.P. (the Partnership), a real estate limited partnership that owns and operates an office building. The Corporation's interest in the limited partnership had previously been accounted for as an investment under the equity method of accounting. As a result of adopting Interpretation No. 46(R), the Corporation has restated its previously reported December 31, 2003 Consolidated Balance Sheets and its June 30, 2003 Consolidated Statements of Income and Comprehensive Income as follows: December 31, 2003 As As Previously Reported Restated ------------------- -------- (in thousands) Consolidated Balance Sheets: Assets Nonutility property $ 29,665 $ 34,918 Less: accumulated depreciation 2,036 2,349 -------- -------- Net nonutility property $ 27,629 $ 32,569 -------- -------- Cash and equivalents 10,036 10,278 Total current assets 27,098 27,340 Investment in affiliate 1,110 - Other assets 5,594 6,049 Total other assets 48,266 47,611 Total assets 511,717 516,244 Liabilities: Long-term debt $139,614 $143,947 Total capitalization 305,982 310,315 Other noncurrent liabilities 11,330 11,524 Total capitalization & liabilities 511,717 516,244 Three Months Ended June 30, 2003 As As Previously Reported Restated ------------------- -------- (in thousands) Consolidated Statements of Income and Comprehensive Income: Operating revenue $ 37,968 $ 38,149 Total operating expense 31,712 31,841 Operating income 6,256 6,308 Other, net (33) (86) Net income 4,426 4,426 Comprehensive income 5,964 5,964 Six Months Ended June 30, 2003 As As Previously Reported Restated ------------------- -------- (in thousands) Consolidated Statements of Income and Comprehensive Income: Operating revenue $ 65,759 $ 66,120 Total operating expense 55,527 55,750 Operating income 10,232 10,370 Other, net 19 (119) Net income 9,708 9,708 Comprehensive income 12,609 12,609 There was no cumulative impact on retained earnings that resulted from the adoption of Interpretation No. 46(R). The Partnership has an outstanding mortgage loan in the amount of $4,302,000 as of June 30, 2004. The mortgage loan is due in April 2011 and amortized over twenty-five 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. Note 4. Non-regulated 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 non- regulated business activities of SJW Corp. The non-regulated 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 (SJW Land), 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 regulated and non-regulated business activities for the three and six months ended June 30, 2004 and 2003: Three Months Ended Three Months Ended June 30, 2004 June 30, 2003 ------------------------- ------------------------- (in thousands) Non- Non- Regulated regulated Total Regulated regulated Total --------- --------- ----- --------- --------- ----- Revenue $43,063 $2,546 $45,609 $36,276 $1,873 $38,149 Expenses 36,426 2,073 38,499 30,037 1,804 31,841 ------- ------ ------- ------- ------ ------- Operating Income $ 6,637 $ 473 $ 7,110 $ 6,239 $ 69 $ 6,308 ======= ====== ======= ======= ====== ======= Six Months Ended Six Months Ended June 30, 2004 June 30, 2003 ------------------------- ------------------------- (in thousands) Non- Non- Regulated regulated Total Regulated regulated Total --------- --------- ----- --------- --------- ----- Revenue $72,114 $4,558 $76,672 $62,683 $3,437 $66,120 Expenses 62,036 3,541 65,577 52,738 3,012 55,750 ------- ------ ------- ------- ------ ------- Operating Income $10,078 $1,017 $11,095 $ 9,945 $ 425 $10,370 ======= ====== ======= ======= ====== ======= Note 5. Depreciable Plant and Equipment ---------------------------------------- The major components of depreciable plant and equipment as of June 30, 2004 and December 31, 2003 are as follows: June 30, December 31, 2004 2003 -------- ------------ (in thousands) Equipment $ 47,667 $ 49,071 Transmission and distribution 462,176 455,030 Office building and other structures 76,089 66,018 -------- -------- Total $585,932 $570,119 ======== ======== Depreciation of depreciable plant and equipment is computed using the straight-line method over the estimated service lives of the assets, ranging from 5 to 75 years. The estimated service lives of utility plant are as follows: Useful Lives ------------ Equipment 5 to 35 years Transmission and distribution plant 35 to 75 years Office buildings and other structures 7 to 50 years Note 6. Nonutility Property ---------------------------- The major components of net nonutility property as of June 30, 2004 and December 31, 2003 are as follows: June 30, December 31, 2004 2003 -------- ----------- (in thousands) Land $ 9,917 $ 9,485 Buildings and improvements 25,165 25,202 Intangibles 231 231 Less: accumulated depreciation and amortization 2,818 2,349 -------- ------- Total $ 32,495 $32,569 ======== ======= Depreciation of nonutility property is computed using the straight-line method over the estimated service lives of the assets, ranging from 5 to 75 years. Refer to Note 5. Depreciable Plant and Equipment for the estimated service lives of nonutility property. Note 7. 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 six months ended June 30, 2004 and 2003 are as follows: Three months Six months ended June 30 ended June 30 2004 2003 2004 2003 ------------------------------------ (in thousands) Service cost $ 438 354 $ 876 708 Interest cost 762 685 1,524 1,370 Other cost 238 189 476 378 Expected return on Assets (639) (548) (1,278) (1,096) ----- ---- ------- ----- $ 799 680 $ 1,598 1,360 ===== ==== ======= ===== In June 2004, the Corporation made a contribution of $2,300,000 to the pension plan and expects to contribute $297,000 to its other post-retirement plan in 2004. Note 8. 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 thirty-six months. On May 28, 2004, SJW Corp. repurchased 895 shares of its outstanding common stock at the prevailing price in the open market at an aggregate cost of $29,000. All repurchased shares have been cancelled and are considered authorized and unissued. Note 9. Segment Reporting -------------------------- SJW Corp. is a holding company with three subsidiaries: San Jose Water Company (SJWC), a water utility operation with both regulated and nonregulated businesses, SJW Land Company (SJW Land), 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 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 one reportable business segment, that of providing water utility and utility-related services to its customers. These services are provided through the Corporation's subsidiary, SJWC. The Corporation's reportable segment has 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 (loss) and total assets. The tables below set forth information relating to SJW Corp.'s reportable segment. Certain allocated assets, revenue and expenses have been included in the reportable segment amounts. Other business activity from the Corporation not included in the reportable segment is included in the "All Other" category. For three months ended June 30, 2004 (in thousands) --------------------------------------- All SJW SJWC Other* Corp. ------------ ---------- ----------- Operating revenue $ 44,181 $ 1,428 $ 45,609 Operating expense $ 37,434 $ 1,065 $ 38,499 Net income $ 4,460 $ 347 $ 4,807 Depreciation and amortization $ 4,513 $ 194 $ 4,707 Interest on long-term debt $ 2,382 - $ 2,382 Total assets $463,535 $65,943 $529,478 For three months ended June 30, 2003 (in thousands) --------------------------------------- All SJW SJWC Other* Corp. ------------ ---------- ----------- Operating revenue $ 37,075 $ 1,074 $ 38,149 Operating expense $ 30,780 $ 1,061 $ 31,841 Net income $ 4,194 $ 232 $ 4,426 Depreciation and amortization $ 3,678 $ 147 $ 3,825 Interest on long-term debt $ 2,106 - $ 2,106 Total assets $430,704 $66,136 $496,840 For six months ended June 30, 2004 (in thousands) --------------------------------------- All SJW SJWC Other* Corp. ------------ ---------- ----------- Operating revenue $ 73,840 $ 2,832 $ 76,672 Operating expense $ 63,385 $ 2,192 $ 65,577 Net income $ 5,877 $ 704 $ 6,581 Depreciation and amortization $ 8,758 $ 342 $ 9,100 Interest on long-term debt $ 4,764 - $ 4,764 Total assets $463,535 $65,943 $529,478 For six months ended June 30, 2003 (in thousands) --------------------------------------- All SJW SJWC Other* Corp. ------------ ---------- ----------- Operating revenue $ 64,066 $ 2,054 $ 66,120 Operating expense $ 53,806 $ 1,944 $ 55,750 Net income $ 8,665 $ 1,043 $ 9,708 Depreciation and amortization $ 7,358 $ 207 $ 7,565 Interest on long-term debt $ 4,192 - $ 4,192 Total assets $430,704 $66,136 $496,840 * The "All Other" category includes SJW Land, CCWS and the holding company. Please refer to Results of Operation under Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations for revenue from SJW Land and CCWS activity. The holding company does not engage in revenue generating activity. Note 10. Commitments --------------------- 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 SJW Corp.'s commitments. 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" 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 under the section entitled "Factors that May Affect Future Results" 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 three 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. It 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-regulated water related services under agreements with municipalities. These non-regulated 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. Crystal Choice Water Service LLC, a subsidiary 75% owned by SJW Corp., engages in the sale and rental of water conditioning and purification equipment. SJW Corp. also owns 1,099,952 shares of California Water Service Group, which represents approximately 7% of its outstanding shares as of December 31, 2003. 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 the Corporation's business operations is discussed throughout "Management's Discussion and Analysis of Financial Condition and Results of Operations" where such policies affect the Corporation's reported and expected financial results. The Corporation's critical accounting policies are as follows: Balancing Account The California Public Utilities Commission (CPUC) establishes a balancing account mechanism within its regulatory regime. A separate balancing account must be maintained for each offset expense item (e.g. purchased water, purchased power and pump tax). 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. Since balances are being tracked and have to be approved 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 increased by the amount of balancing account over-collection, or decreased by the amount of balancing account under-collection, less applicable taxes, as the case may be. At June 30, 2004 and December 31, 2003, the balancing account had a net balance as follows: June 30 December 31 2004 2003 -------- ----------- (in thousands) Under-collection accrued prior to November 29, 2001 $ 382 $ 382 Over-collection accrued from November 30, 2001 to period end (91) (389) ------ ------- Net under/(over)-collected balance $ 291 $ (7) ====== ====== Revenue Recognition San Jose Water Company's revenue from metered customers includes billings to customer based on meter readings plus an estimate of water used between the customers' last meter reading and the end of the accounting period. The 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 June 30, 2004 and December 31, 2003, accrued unbilled revenue was $13,071,000 and $6,205,000, respectively. SJW Corp. recognizes its non-regulated revenue based on the nature of the non-regulated business activities. Revenue from San Jose Water Company's non-regulated utility operations and billing or maintenance agreements are recognized in accordance with SEC Staff Accounting Bulletin 104, "Revenue Recognition", when services have been rendered. Revenue from SJW Land Company is recognized ratably over the term of the lease or when parking services has 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 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 regulatory asset as a cost for financial reporting purposes. No disallowance had to be recognized at June 30, 2004 and December 31, 2003. The net regulatory assets recorded by San Jose Water Company as of June 30, 2004 and December 31, 2003 was $8,337,000 and $7,976,000, 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. 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 costs. San Jose Water Company, through its Retirement Plan Administrative Committee managed by the representatives from the unions and management establishes investment guidelines with specification that at least 30% of the investments are in bonds or cash. As of December 31, 2003, the plan assets consist of approximately 22% bonds, 11% cash and 67% equities. Furthermore, equities are to 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. The market values of the plan assets are marked to market at the measurement date. The investment trust assets incurred unrealized market losses in the three years prior to 2003. Unrealized market losses on pension assets are amortized over 14 years for actuarial expense calculation purposes. The Corporation utilizes Moody's 'A' and 'Aa' rated bonds in industrial, utility and financial sectors with outstanding amount of $1 million or more in determining the discount rate used in calculating the liabilities at the measurement date. For the year ending December 31, 2003, the composite discount rate used was 6.25%. Stock-Based Compensation Plans SJW Corp. has a stockholder-approved long-term incentive plan that allows granting of nonqualified stock options, performance shares, restricted stock units and dividend units. Under the plan, a total of 900,000 common shares are authorized for awards and grants. The Corporation 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 include: expected dividend yield of 3.4%, expected volatility of 27%, risk-free interest rate of 2.86%, expected holding period of five years. In addition to the option grants, SJW Corp. has granted restricted stock units to a key employee of the Corporation, which was valued at market price at the date of grant. The Corporation is correspondingly recognizing the fair market value of the restricted stock granted as compensation expense, over the vesting period of three years. Additionally, restricted stock units granted to non-employee Board members from the conversion of cash pension benefits were valued at market price at the date of grant. The Corporation is correspondingly recognizing the fair market value of the unvested restricted stock granted as compensation expense, over the vesting period of three years. Consolidation Policy of Majority-Owned Enterprises SJW Corp. consolidates its 75% controlling interest at Crystal Choice Water Service 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" in the Balance Sheet. Effective January 1, 2004, the Corporation adopted FASB Interpretation No. (FIN) 46R, "Consolidation of Variable Interest Entities". As a result of the adoption of FIN 46R, the Corporation has identified its investment in 444 West Santa Clara Street, L. P. as a variable interest entity and that SJW Land Company as the primary beneficiary. SJW Corp. has consolidated 444 West Santa Clara Street, L.P. in its consolidated financial statements as of January 1, 2004 and restated its prior periods financial statements to reflect the consolidation on a comparative basis. Recent Accounting Pronouncements: -------------------------------- In January 2003, the Financial Accounting Standards Board (FASB) issued Interpretation No. 46, "Consolidation of Variable Interest Entities", which addresses how a business enterprise should evaluate whether it has a controlling financial interest in an entity through means other than voting rights and accordingly should consolidate the entity. In December 2003, FIN 46R was issued to replace FASB Interpretation No. 46. For any variable interest entities (VIE or VIEs) that must be consolidated under FIN 46R that were created before January 1, 2004, the assets, liabilities and non controlling interests of the VIE initially are measured at their carrying amounts with any difference between the net amount added to the balance sheet and any previously recognized interest being recognized in the cumulative effect of an accounting change. If determining the carrying amounts is not practicable, fair value at the date FIN 46R first applies may be used to measure the assets, liabilities and non controlling interest of the VIE. The adoption of FIN 46R has resulted in the consolidation of the Corporation's 70% limited partnership interest in 444 West Santa Clara Street L.P. as of January 1, 2004 which had previously been accounted for under the equity method of accounting. In December 2003, the SEC issued Staff Accounting Bulletin No. 104 (SAB 104), "Revenue Recognition". SAB 104 supercedes SAB 101 (SAB 101), "Revenue Recognition in Financial Statements". The primary purpose of SAB 104 is to rescind accounting guidance contained in SAB 101 related to multiple element revenue arrangements, superceded as a result of the issuance of Emerging Issues Task Force (EITF) Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables". Additionally, SAB 104 rescinds the SEC's "Revenue Recognition in Financial Statements Frequently Asked Questions and Answers (the FAQ) issued with SAB 101 that had been codified in SEC Topic 13, "Revenue Recognition". Selected portions of the FAQ have been incorporated into SAB 104. While the wording of SAB 104 has changed to reflect the issuance of EITF 00-21, the revenue recognition principles of SAB 101 remain largely unchanged by the issuance of SAB 104. The adoption of SAB 104 did not have a material impact on the Corporation's financial position, results of operations or cash flows. In May 2004, the FASB issued FASB Staff Position (FSP) No. 106-2, "Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003". The major provision under FSP No. 106-2 would require employers that qualify for a prescription-drug subsidy under Medicare legislation enacted in December 2003 to recognize the reduction in costs as employees provide services in future years. The FSP No. 106-2 also explains how to account for the effect of the law's federal benefit to retirees on per capita claims costs, the relevant accounting for income taxes, and required disclosures. The adoption of the FSP No. 106-2 has not had an impact on the Corporation's financial position, results of operations or cash flows due to cost savings are passed through to the retirees. In June 2004, the SEC issued Emerging Issues Task Force (EITF) Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments" for investments accounted for under FASB No. 115, "Accounting in Certain Investments in Debt and Equity Securities", and FASB No. 124, "Accounting for Certain Investments Held by Not-for-Profit Organizations, effective June 15, 2004. The adoption of the EITF Issue No. 03-1 will not have a material impact on the Corporation's financial position, results of operations or cash flows. Liquidity and Capital Resources: -------------------------------- San Jose Water Company's budgeted capital expenditures for 2004, exclusive of capital expenditures financed by customer contributions and advances, are $31,158,000 with capital expenditures concentrated in water main replacements. Approximately $12,000,000 will be spent to replace San Jose Water Company's mains in 2004. Starting in 1997, San Jose Water Company began a four-phased Infrastructure Study establishing a systematic approach to replace its utility infrastructure. Phase I and II of the Infrastructure Study analyzed the company's pipes and mains. Phase 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 the company's future improvements. 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. The company expects to incur approximately $176,000,000 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. The 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 because certain new facilities are constructed using 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. 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 June 30, 2004, 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 2004. 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 June 30, 2004, San Jose Water Company's funded debt and equity were 49.20% and 50.80%, respectively. Company internally generated funds, which includes allowance for depreciation and deferred income taxes, have provided approximately 50% of the future cash requirements for San Jose Water Company's capital expenditure. Due to its strong cash position and low financial leverage 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 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, 2004. The senior note agreements of San Jose Water Company generally have terms and conditions that restrict the 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 twelve calendar month period would be less than 175% of interest charges. As of June 30, 2004, San Jose Water Company's funded debt was 49.2% of total capitalization and the net income for preceding twelve months was 371% of interest charges. In 2002, the Department of Water Resources approved San Jose Water Company's application for an approximately $2,500,000 Safe Drinking Water State Revolving Fund twenty-year loan at an interest rate of 2.39%. Funds in the above amount will be used for the retrofit of San Jose Water Company's water treatment plant. As of June 30, 2004, the loan has not been funded. San Jose Water Company will request the funding in 2004 when the loan documentation and contract requirements are met. 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 amount of $9,900,000 in April 2003. The mortgage loans are due in ten years and amortized over twenty-five 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 the 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 twenty 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 $4,321,000 as of June 30, 2004. The mortgage loan is due in April 2011 and amortized over twenty-five 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. 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. At June 30, 2004, 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, 2005. Results of Operations --------------------- Overview -------- SJW Corp.'s consolidated net income for the three months ended June 30, 2004 was $4,807,000, an increase of $381,000 or 9% from $4,426,000 in the second quarter of 2003. Six months earnings was $6,581,000, a decrease of $3,127,000 or 32% from $9,708,000 for the same period in 2003. The six months earnings decrease was primarily due to an after-tax gain of $3,030,000 from the sale of a SJW Land Company property recognized in the first quarter of 2003. Operating Revenue ----------------- Operating Revenue by Subsidiary Three months ended Six months ended June 30 June 30 2004 2003 2004 2003 (Restated) (Restated) -------------------------------------- (in thousands) San Jose Water Company $44,181 $37,075 $73,840 $64,066 SJW Land Company 990 723 1,927 1,449 Crystal Choice Water Service 438 351 905 605 ----------------- ----------------- $45,609 $38,149 $76,672 $66,120 ================= ================= Operating revenue for the second quarter was $45,609,000 versus $38,149,000 for the same period in 2003, representing an increase of $7,460,000 or 20%. Approximately $4,571,000 of the total revenue was attributable to higher customer demand, which increased revenue by 12% as a result of warmer temperatures in April and May, 2004 and $2,535,000 increase was due to cumulative rate increases totaling 7%. For the six months ended June 30, 2004, the increase of $10,552,000 or 16% in operating revenue from the same period in 2003, was primarily due to the reasons as explained above. SJW Land Company's lease revenue increased by $267,000 and $478,000 for the second quarter and six months ended June 30, 2004, respectively, was primarily due to the addition of two commercial properties in March 2003 to its portfolio. Crystal Choice Water Service LLC's revenue increased by $87,000 and $300,000 for the second quarter and six months ended June 30, 2004, respectively, over 2003 due to an improved marketing strategy. The change in consolidated operating revenue was due to the following factors: Three months ended Six months ended June 30 2004 vs. 2003 June 30 2004 vs. 2003 Increase/(decrease) Increase/(decrease) ------------------------------------------ Utility: (in thousands) Consumption changes $ 4,470 12% $ 5,345 8% New customers increase 101 - 161 - Rate increases 2,535 7% 4,268 6% Parking and rental 267 1% 478 1% Crystal Choice Water Service 87 - 300 1% --------------- --------------- $ 7,460 20% $ 10,552 16% =============== =============== Operating Expenses ------------------ Operating Expenses by Subsidiary Three months ended Six months ended June 30 June 30 2004 2003 2004 2003 (Restated) (Restated) ------------------------------------------ (in thousands) San Jose Water Company $37,434 30,780 $63,385 53,806 SJW Land Company 459 537 977 990 Crystal Choice Water Service 439 371 881 685 SJW Corp. 167 153 334 269 ----------------- ---------------- $38,499 31,841 $65,577 55,750 ================ ================ The change in operating expenses from the same period in 2003 was due to the following factors: Three months ended Six months ended June 30 2004 vs. 2003 June 30 2004 vs. 2003 Increase/(decrease) Increase/(decrease) -------------------------------------------- (in thousands) Water production costs: Decreased surface water supply $ 411 1% $ 777 1% Usage and new customers 3,041 10% 3,575 6% Pump tax and purchased water price increase 1,414 4% 2,286 4% Energy prices (151) - (330) - ------------- -------------- Total water production costs 4,715 15% 6,308 11% ------------- -------------- Non-water production costs: Administrative and general 301 1% 841 2% Other operating expense 82 - 245 1% Maintenance 276 1% 611 1% Property taxes and other non-income taxes 103 - 163 - Depreciation and amortization 882 3% 1,535 3% ------------- ------------- Total non-water production costs 1,644 5% 3,395 7% ------------- ------------- Income taxes 299 1% 124 - ------------- ------------- Total operating expenses $6,658 21% $9,827 18% ============= ============= Water production costs increased $4,715,000 or 15% of total costs and expensesfor the second quarter of 2004. The higher costs was primarily attributable to increases of $1,263,000 in the cost of purchased water and pump taxes from Santa Clara Valley Water District (SCVWD) offset by lower energy prices, $411,000 due to reduced surface water availability and $3,041,000 due to higher customer demand. For the six months ended June 30, 2004, the increase of $6,308,000 in total water production costs from the same period in 2003 was due to the reasons as explained above. San Jose Water Company's water supply consists of groundwater from wells, surface water from watershed run-off and diversion, and imported water purchased from the SCVWD. Surface water is the least expensive source of water and due to the decreased surface water availability in the second quarter of 2004, the water production costs increased by $411,000. Water production for the three months and six months ended June 30, 2004 increased 2,205 million gallons and 2,533 million gallons from the same period in 2003. During these periods, the availability of surface water was significantly lower than the same periods in 2003. The change in San Jose Water Company's source of supply mix was as follows: Three months ended Six months ended June 30 2004 vs. 2003 June 30 2004 vs. 2003 Increase/(decrease) Increase/(decrease) -------------------------------------------- (in million gallons) Purchased water 1,329 6% 1,188 6% Ground water (291) (1%) (550) (3%) Surface water 1,103 5% 1,815 9% Reclaimed water 64 - 80 - --------------- --------------- 2,205 10% 2,533 12% =============== =============== The changes in the source of supply mix were consistent with the changes in the water production costs. The non-water production costs, which include administrative, other operating expense, maintenance, property taxes and other non-income taxes, depreciation and amortization in the second quarter of 2004, increased $1,644,000 compared to the same period in 2003. The increase in Administrative and General expenses included $168,000 in pension costs primarily as a result of the enhancement of pension plan benefits. Depreciation expense increased $882,000 due to higher investment in utility plants. Other increases include $209,000 in legal and professional fees, $124,000 in insurance and related costs, $202,000 in contracted work related to various projects and $59,000 in other costs. For the six months ended June 30, 2004, the non-water production costs increased by $3,395,000 over the same period in 2003. The increase in Administrative and General expenses included $294,000 in pension costs primarily as a result of the enhancement of pension plan benefits. Depreciation expense increased $1,535,000 due to higher investment in utility plants. Other increases include $194,000 in legal and professional fees, $200,000 in insurance and related costs, $128,000 in contracted work related to various projects, $754,000 in wages, salaries and stock compensation, and $290,000 in other costs. Income tax expense for the second quarter and six months ended June 30, 2004 increased by $299,000 and $124,000, respectively, over the same periods in 2003 due to higher earnings in 2004. The effective income tax rates for the periods ended June 30, 2004 and 2003 both approximated 41%. The increase in interest expense for the second quarter and six months ended June 30, 2004 from the same periods in 2003 was the result of higher interest expenses due to the issuance of Series G senior notes and the long-term debt associated with the commercial properties in Connecticut and Florida. The changes in comprehensive income for the three months and six months ended June 30, 2004 and 2003 were due to the increase in market value of the investment in California Water Service Group. Factors That May Affect Future Results -------------------------------------- Non-regulated Operations ----------------------- In January 2002, SJW Land Company entered into an Agreement for Possession and Use (Agreement) with Valley Transportation Agency (VTA) whereby SJW Land Company has granted VTA an irrevocable right to possession and use of 1.23 acres of the company's parking lot property for the development of a light rail station. VTA has adopted a resolution authorizing a condemnation proceeding to acquire the land and has deposited $3.7 million in an escrow account as fair market compensation. SJW Land Company waived the right to challenge VTA's possession and use in any subsequent eminent domain proceeding but reserved the right to assert, and has disputed the fair market value placed on the land. According to the terms of the Agreement, if a settlement was not reached within three months of the execution of the Agreement, VTA can file an eminent domain complaint to acquire title to the parking lot property. On April 11, 2003, VTA filed the eminent domain lawsuit. As a part of the proceedings, VTA has transferred funds from the escrow account into a court deposit account to secure its ongoing right of possession for construction of the light rail station pending final litigation. Compensation for the taking of property will be determined by the court or by way of settlement between SJW Land Company and VTA. A trial was held on July 21, 2004. No judgment was made and the trial was rescheduled to October 25, 2004. This transaction will be recorded and is expected to result in an increase to net income when the compensation issue is settled or a final court order is rendered. 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 from the SCVWD under the terms of a master contract with SCVWD expiring in 2051. Groundwater level in 2004 remains comparable to the 30-year normal level. On July 14, 2004, the SCVWD's ten reservoirs were 55.35% full with 93,497 acre-feet of water in storage. The rainfall in the first six months of 2004 was approximately 81% of historical season average. Rainfall at San Jose Water Company's Lake Elsman was measured at 39.07 inches for the season of July 1, 2003 through June 30, 2004, which approximated the five-year average. Local surface water is a less costly source of water and its availability significantly impacts the 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 continue 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 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, exclusive of the years 2001 to 2002 expenditures. These improvements shall be incorporated into the capital budgets to be completed by 2005. San Jose Water Company is continuing implementation of security related to capital improvements in 2004 and $860,000 is expected to be spent in 2004. Once completed, San Jose Water Company believes it will have substantially reduced its vulnerability to terrorists' attack. 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. Regulatory Affairs ------------------ Almost all 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. On May 23, 2003, San Jose Water Company filed a General Rate Case application with the CPUC to increase rates by $25,793,000 or 18.2% in 2004, $5,434,000 or 3.2% in 2005, and $5,210,000 or 3.0% in 2006. San Jose Water Company is seeking these proposed increases to cover higher costs of providing water service, including higher costs of power, purchased water, pump tax, labor, security, water quality testing and reporting, and to allow for necessary improvements to the water system. San Jose Water Company is also requesting rate recovery of 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. Finally, San Jose Water Company is requesting a rate of return on equity of 11.5% for the years 2004 through 2006. Effective January 1, 2004, the CPUC allowed San Jose Water Company an interim rate increase of approximately 2% as they have not reached a decision on the General Rate Case application. A CPUC decision on the application is anticipated in August 2004. Pursuant to Public Utilities Code Section 455.2, San Jose Water Company is allowed revenue true-up from the time of the implementation of the interim rates on January 1, 2004 to the time of the CPUC's ultimate decision in the general rate case. In principal, this mechanism is designed to eliminate the adverse financial impact on water utilities caused by regulatory delays in general rate cases. On May 6, 2004, San Jose Water Company filed Advice Letter No. 348 with the CPUC requesting a revenue increase of $4,600,000, or approximately 3.6%. The requested revenue increase is the result of the increased cost of purchased water and higher pump tax charged to San Jose Water Company by the Santa Clara Valley Water District. The requested revenue increase was authorized effective July 13, 2004. On July 19, 2004, the CPUC issued a proposed decision in San Jose Water Company's general rate case proceeding. The proposed decision granted San Jose Water Company authority to increase rates by $11,800,000 or 8% in 2004, $4,300,000 or 2.7% in 2005 and $4,200,000 or 2.6% in 2006. The proposed decision authorized a return on common equity in 2004, 2005 and 2006 of 9.9%, which is within the range of recent rates of return authorized by the CPUC for water utilities. It is expected that the proposed decision will be considered by the CPUC at its meeting scheduled for August 19, 2004. Balancing Account Recovery Procedures ------------------------------------- On March 16, 2004 the California Public Utilities affirmed its June 19, 2003 decision (D.03-06-072), in which the Commission 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 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 below the line 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. As mentioned above in the general rate case, filed in May 2003, San Jose Water Company has requested recovery of an under- collection of $382,000 accrued in pre-November 29, 2001 Balancing Account via a customer surcharge. Subsequently, on September 9, 2003 and March 30, 2004, San Jose Water Company filed two compliance filings requesting Commission review of the balancing account over-collected balance of approximately $389,000, accrued between November 29, 2001 and December 31, 2003. As this amount is immaterial as compared to overall revenue, rather than refunding the balance, San Jose Water Company proposed that this balance be carried forward to the next review period scheduled for March 2005. On June 15, 2004, the Commission notified the San Jose Water Company that the over-collected balances had been verified and should be carried forward to the next review period. The total ending balancing account balance as of June 30, 2004, including all the outstanding balances currently pending before the Commission, is a net under-collection of $291,000. At June 30, 2004 and December 31, 2003, the balancing account had a net balance as follows: June 30 December 31 2004 2003 -------- ----------- (in thousands) Under-collection accrued prior to November 29, 2001 $ 382 $ 382 Over-collection accrued from November 30, 2001 to period end (91) (389) ------ ------ Net under/(over)-collected balance $ 291 $ (7) ====== ====== 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 the Corporation'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 Rules 13(a)-15(e) and 15d-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) Changes in internal controls. There has been no change in internal control over financial reporting during the second fiscal quarter of 2004 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. Other than as disclosed regarding the eminent domain proceeding in "Nonregulated Operations" under Item 2, "Management's Discussion and Analysis of Financial Condition and Results of Operations", there are no other pending legal proceedings to which the Corporation 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 the Corporation's financial position, results of operations or cash flows. ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES Total Maximum Number Number of Shares of Shares Purchased that May Total Average as Part of Yet Be Number Price Publicly Purchased of Shares Paid per Announced Under the Period Purchased Share Plan Plan ----------------------------------------------------------------- May 1, 2004- May 31, 2004 895 $32.50 895 99,105 --- ------ --- ------ Total 895 $32.50 895 99,105 === ====== === ====== 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 thirty-six months period following its announcement. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS At the 2004 Annual Meeting of Shareholders of the SJW Corp. held on April 29, 2004, an amendment of the By-Laws of the Corporation was approved, eight individuals listed below were re-elected to the Board of Directors, KPMG LLP was appointed as independent auditors for 2004 and the authority to vote in the discretion of the proxy holders was ratified by the following votes: Proposal 1: Amendment of the By-Laws of the Corporation. In Favor Against Abstain Broker Non-votes -------- ------- ------- ---------------- 6,606,066 59,997 21,802 1,525,124 Proposal 2: Election of Directors. Name of Director In Favor Against ---------------- -------- ------- Mark L. Cali 8,176,001 36,988 J. Philip DiNapoli 8,152,346 60,643 Drew Gibson 8,165,927 47,062 Douglas King 8,125,249 87,740 George E. Moss 8,168,494 44,495 W. Richard Roth 8,173,178 39,811 Charles J. Toeniskoetter 8,151,446 61,543 Frederick R. Ulrich 8,126,512 86,477 Proposal 3: Ratification of appointment of independent auditors for 2004: In Favor Against Abstain Broker Non-votes -------- ------- ------- ---------------- 8,129,747 54,100 29,142 - Proposal 4: Ratification of authority to vote in the discretion of the proxy holders: In Favor Against Abstain Broker Non-votes -------- ------- ------- ---------------- 7,403,492 754,765 54,732 - ITEM 5. OTHER INFORMATION On July 29, 2004, the Board of Directors of the SJW Corp. declared the regular quarterly dividend of $0.255 per common share. The dividend will be paid September 1, 2004, to shareholders of record as of the close of business on August 9, 2004. In accordance with Section 10A(i)(2) of the Securities Exchange Act of 1934, as added by Section 202 of the Sarbanes-Oxley Act of 2002, SJW Corp. is responsible for disclosing the non-audit services approved by SJW Corp.'s Audit Committee to be performed by KPMG LLP, SJW Corp.'s independent auditor. Non-audit services are defined in the law as services other than those provided in connection with an audit or a review of the financial statements of SJW Corp. The non-audit services approved by the Audit Committee in the second quarter of 2004 are considered by SJW Corp. to be audit-related services that closely relate to the financial audit process. Each of the services has been approved in accordance with a pre-approval from the Audit Committee's Chairman pursuant to delegated authority by the Audit Committee. During the quarterly period covered by this filing, the Audit Committee approved additional engagements of KPMG LLP for the following non-audit service: tax return preparation, audit related accounting services, and tax matter consultations concerning federal and state taxes. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a.) Exhibits required to be filed by Item 601 of Regulation S-K. 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 June 30, 2004. (b.) Reports on Form 8-K. SJW Corp. filed a current report on Form 8-K with the Securities and Exchange Commission on May 3, 2004 to furnish its press release that announced its Stock Repurchase Program to repurchase up to 100,000 shares under Item 5 thereof and its financial results for the first quarter ended March 31, 2004 under Item 12 thereof. 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: August 6, 2004 By /s/ Angela Yip ----------------- ANGELA YIP Chief Financial Officer and Treasurer Vice President - Finance EXHIBIT INDEX ------------- Exhibit No. Description of Document ------- ----------------------- 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. 1