| and its subsidiaries may be adversely affected by new and changing legislation, policies and regulations |
| New legislation and changes in existing legislation by federal, state and local governments and administrative agencies can affect the operations of SJW Corp |
| and its subsidiaries |
| San Jose Water Company is regulated by the CPUC The operating revenue of San Jose Water Company results from the sale of water at rates authorized by the CPUC The CPUC sets rates that are intended to provide revenues sufficient to recover operating expenses and produce a reasonable return on common equity |
| As required by law, San Jose Water Company files general rate applications with the CPUC on a periodic basis |
| As required, on December 9, 2005, San Jose Water Company filed a draft General Rate Case application (Proposed Application) with the CPUC seeking authority to increase rates for 2007, 2008 and 2009 to recover the higher costs of providing water service, including higher costs of labor, security, water 11 quality testing and reporting, and to allow for necessary improvements to the water system |
| The draft filing is a preliminary filing that allows the CPUC to identify any procedural deficiencies so that they may be corrected prior to the filing of the actual General Rate Case Application |
| It is anticipated that the General Rate Case application for San Jose Water Company was submitted to the CPUC in February 2006 |
| Although San Jose Water Company believes that the rates currently in effect provide it with a reasonable rate of return, there is no guarantee such rates will be sufficient to provide a reasonable rate of return in the future |
| There is no guarantee that the companyapstas future rate filings will be able to obtain a satisfactory rate of return in a timely manner |
| In addition, San Jose Water Company relies on policies and regulations promulgated by the CPUC in order to recover capital expenditures, maintain favorable treatment on gains from the sale of real property, offset its production and operating costs, recover the cost of debt, maintain an optimal equity structure without over-leveraging, and have financial and operational flexibility to engage in nonregulated operations |
| If the CPUC implements policies and regulations that do not allow San Jose Water Company to accomplish some or all of the items listed above, San Jose Water Companyapstas future operating results may be adversely affected |
| Pursuant to Section 792dtta5 of the California Public Utilities Code, a balancing account must be kept for each expense item for which revenue offsets have been authorized (ie, 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 |
| On November 29, 2001, the CPUC issued Resolution W-4294 (the Resolution) implementing significant changes in the long-established offset rate increase and balancing account recovery procedures applicable to water utilities |
| These changes could have a significant impact on the risk profile of the water industry |
| As required by the Resolution, in December 2001, the CPUC opened an Order Instituting Rulemaking (OIR) to evaluate existing balancing account and offset rate practices and policies |
| On June 19, 2003 the CPUC issued its final OIR decision (D03-06-072) in which the CPUC revised the existing procedures for recovery of under collections and over collections in balancing accounts existing on or after November 29, 2001, as follows: (1) If a utility is within its rate case cycle and is not over earning, the utility shall recover its balancing account subject to reasonableness review; and (2) If a utility is either within or outside of its rate case cycle and is over earning, the utilityapstas recovery of expenses from the balancing accounts will be reduced by the amount of the over earning, again subject to reasonableness review |
| Utilities shall use the recorded rate of return test to evaluate earnings for all years |
| It is uncertain how any future CPUC regulation dealing with balancing account balances accrued after November 29, 2001 will affect San Jose Water Companyapstas ability to collect such balance or to receive future offset rate relief |
| As of December 31, 2005, the net amount of the CPUC reviewed accounts and those pending review are an under-collection of dlra244cmam000 |
| 12 As of December 31, 2005, San Jose Water Company has received all its offset rate requests |
| Any future impact on San Jose Water Companyapstas ability to recover balancing account balances and receive offset rate increases cannot be determined at least until San Jose Water Companyapstas next offset rate increase request, which is anticipated for July 2006 |
| Changes in water supply, water supply costs or the mix of water supply could adversely affect the operating results and business of San Jose Water Company |
| San Jose Water Companyapstas supply of water primarily relies upon three main sources: water purchased from the SCVWD, surface water from its Santa Cruz Mountains Watershed, and pumped underground water |
| Changes and variations in quantities from each of these three sources affect the overall mix of the water supply, therefore affecting the cost of water supply |
| Surface water is the least costly source of water |
| If there is an adverse change to the mix of water supply and San Jose Water Company is not allowed by the CPUC to recover the additional or increased water supply costs, its operating results may be adversely affected |
| The SCVWD receives an allotment of water from state and federal water projects |
| If San Jose Water Company has difficulties obtaining a high quality water supply from the SCVWD due to availability or legal restrictions, it may not be able to satisfy customer demand in its service area and its operating results and business may be adversely affected |
| Additionally, the availability of water from San Jose Water Companyapstas Santa Cruz Mountains Watershed depends on the weather and fluctuates with each season |
| In a normal year, surface water supply provides 6-8prca of the total water supply of the system |
| In a dry season with little rainfall, water supply from surface water sources may be low, thereby causing San Jose Water Company to increase the amount of water purchased from outside sources at a higher cost than surface water and thus increasing water production costs |
| In addition, San Jose Water Companyapstas ability to use surface water is subject to regulations regarding water quality and volume limitations |
| If new regulations are imposed or existing regulations are changed or given new interpretations, the availability of surface water may be materially reduced |
| A reduction in surface water could result in the need to procure more costly water from other sources, thereby increasing the water production costs and adversely affecting the operating results of San Jose Water Company |
| Because the extraction of water from the groundwater basin and the operation of the water distribution system require a significant amount of energy, increases in energy prices could increase operating expenses of San Jose Water Company |
| In the aftermath of the attempt to deregulate the California energy market, energy costs still remain in flux, with resulting uncertainty in the companyapstas ability to contain energy costs into the future |
| San Jose Water Company continues to utilize Pacific Gas & Electricapstas time of use rate schedules to minimize its overall energy costs primarily for groundwater pumping |
| During the winter months, typically 90prca or more of the groundwater is produced during off-peak hours when electrical energy is consumed at the lowest rates |
| Optimization and energy management efficiency is achieved through the implementation of Supervisory Control and Data Acquisition (SCADA) 13 system software applications that control pumps based on demand and cost of energy |
| An increase in demand or a reduction in the availability of surface water or import water could result in the need to pump more water during peak hours adversely affecting the operating results of San Jose Water Company |
| Fluctuations in customer demand for water due to seasonality, restrictions of use, weather and lifestyle can adversely affect operating results |
| San Jose Water Company operations are seasonal |
| Thus, results of operations for one quarter do not indicate results to be expected in subsequent quarters |
| Rainfall and other weather conditions also affect the operations of San Jose Water Company |
| Most water consumption occurs during the third quarter of each year when weather tends to be warm and dry |
| In drought seasons, if customers are encouraged and required to conserve water due to a shortage of water supply or restriction of use, revenue tends to be lower |
| Similarly, in unusually wet seasons, water supply tends to be higher and customer demand tends to be lower, again resulting in lower revenues |
| Furthermore, certain lifestyle choices made by customers can affect demand for water |
| For example, a significant portion of residential water use is for outside irrigation of lawns and landscaping |
| If there is a decreased desire by customers to maintain landscaping for their homes, residential water demand could decrease, which may result in lower revenues |
| Conservation efforts and construction codes, which require the use of low-flow plumbing fixtures, could diminish water consumption and result in reduced revenue |
| A contamination event or other decline in source water quality could affect the water supply of San Jose Water Company and therefore adversely affect the business and operating results |
| San Jose Water Company is subject to certain water quality risks relating to environmental regulations |
| Through water quality compliance programs, San Jose Water Company continually monitors for contamination and pollution of its sources of water |
| In the event of a contamination, San Jose Water Company will likely have to procure water from more costly sources and increase future capital expenditures |
| Although the costs would likely be recovered in the form of higher rates, there can be no assurance that CPUC would approve a rate increase to recover the costs |
| San Jose Water Company is subject to litigation risks concerning water quality and contamination |
| Although San Jose Water Company has not been and is not a party to any environmental and product-related lawsuits, such lawsuits against other water utilities have increased in frequency in recent years |
| If San Jose Water Company is subject to an environmental or product-related lawsuit, it might incur significant legal costs and it is uncertain whether it would be able to recover the legal costs from ratepayers or other third parties |
| In addition, if current California law regarding CPUCapstas preemptive jurisdiction over regulated public utilities for claims about compliance with California Department of Health Services (CDHS) and United States Environmental Protection Agency (EPA) water quality standards changes, the legal exposure of San Jose Water Company may be significantly increased |
| 14 New or more stringent environmental regulations could increase San Jose Water Companyapstas operating costs and affect its business |
| San Jose Water Companyapstas operations are subject to water quality and pollution control regulations issued by the EPA, the CDHS and the California Regional Water Quality Control Board |
| It is also subject to environmental laws and regulations administered by other state and local regulatory agencies |
| Stringent environmental and water quality regulations could increase San Jose Water Companyapstas water quality compliance costs, hamper San Jose Water Companyapstas available water supplies, and increase future capital expenditure |
| Under the federal Safe Drinking Water Act (SDWA), San Jose Water Company is subject to regulation by the EPA of the quality of water it sells and treatment techniques it uses to make the water potable |
| The EPA promulgates nationally applicable standards, including maximum contaminant levels (MCLs) for drinking water |
| There can be no assurance that San Jose Water Company will be able to continue to comply with all water quality requirements |
| San Jose Water Company has implemented monitoring activities and installed specific water treatment improvements enabling it to comply with existing MCLs and plan for compliance with future drinking water regulations |
| However, the EPA and CDHS have continuing authority to issue additional regulations under the SDWA It is possible that new or more stringent environmental standards could be imposed that will raise San Jose Water Companyapstas operating costs |
| Future drinking water regulations may require increased monitoring, additional treatment of underground water supplies, fluoridation of all supplies, more stringent performance standards for treatment plants and procedures to further reduce levels of disinfection byproducts |
| San Jose Water Company continues to seek to establish mechanisms for recovery of government-mandated environmental compliance costs |
| There are currently limited regulatory mechanisms and procedures available to the company for the recovery of such costs and there can be no assurance that such costs will be fully recovered |
| Costs associated with security precautions may have an adverse effect on the operating results of San Jose Water Company |
| Water utility companies have generally been on a heightened state of alert since the threats to the nationapstas health and security in the fall of 2001 |
| San Jose Water Company has taken steps to increase security at its water utility facilities and continues to implement a comprehensive security upgrade program for production and storage facilities, pump stations and company buildings |
| San Jose Water Company also coordinates security and planning information with SCVWD, other Bay Area water utilities and 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 EPA on March 31, 2003 |
| San 15 Jose Water Company has also actively participated in the security vulnerability assessment training offered by the American Water Works Association Research Foundation and the EPA The vulnerability assessment identified system security enhancements that impact water quality, health, safety and continuity of service totaling approximately dlra2cmam300cmam000, exclusive of the years 2001 to 2002 expenditures |
| These improvements were incorporated into the capital budgets and are expected to be completed in the first quarter of 2006 |
| For the years ended December 31, 2005, 2004 and 2003 dlra1cmam031cmam000, dlra643cmam000 and dlra540cmam000, respectively, were spent on capital projects to improve and enhance security |
| 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 |
| While some of these costs are likely to be recovered in the form of higher rates, there can be no assurance that the CPUC will approve a rate increase to recover all or part of such costs, and as a result, the companyapstas operating results and business may be adversely affected |
| In addition, the independent auditors must report on managementapstas evaluation of those controls |
| apstas evaluation of internal controls and the independent auditorapstas evaluation are unable to provide SJW Corp |
| with an unqualified report as to the effectiveness of its internal controls over financial reporting for future year-ends, investors could lose confidence in the reliability of SJW Corp |
| apstas financial statements, which could result in a decrease in the intrinsic value of SJW Corp |
| Other factors that affect operating results Other factors that could adversely affect the operating results of SJW Corp |
| and its subsidiaries include the following: o SJW Corp |
| apstas growth strategy depends on its ability to acquire water systems in order to broaden the service areas, SJW Land Companyapstas ability to continue to develop and invest in the nonutility property at favorable terms, and San Jose Water Companyapstas ability to continue to broaden and expand its nonregulated contract services in the metropolitan San Jose area |
| apstas growth strategy will expose it to different risks than those associated with the utility operations |
| Additional costs are incurred in connection with the execution of the growth strategy and risks are involved in potential integration of acquired businesses/properties which could require significant costs and cause diversion of managementapstas time and resources |
| Any future acquisition SJW Corp |
| apstas core business, impact SJW Corp |
| apstas ability to finance the business and affect its compliance with regulatory requirements |
| Any businesses SJW Corp |
| acquires may not achieve sales, customer growth and projected profitability that would justify the investment and any difficulties 16 SJW Corp |
| encounters in the integration process, including the integration of controls necessary for internal control and financial reporting, could interfere with its operations, reduce its operating margins and adversely affect its internal controls |
| o The successful acquisition of the announced purchase of Canyon Lake Water Supply Corporation depends on SJWapstas ability to operate within the various Texas regulatory regimes, including the economic, environmental and treasury regulatory agencies, retire the existing Canyon Lake Water Supply Corporation mortgaged loan on favorable terms and conditions, to efficiently integrate an out-of-state utility operation and to find cost savings arising from synergies and other unforeseen circumstances |
| o The level of labor and non-labor operating and maintenance expenses as affected by inflationary forces and collective bargaining power could adversely affect the operating and maintenance expenses of SJW Corp |
| o The City of Cupertinoapstas lease operation could be adversely affected by capital requirements, the ability of San Jose Water Company to raise rates through the Cupertino City Council, and the level of operating and maintenance expenses |
| o If recycled water is widely accepted as a substitute for potable water and if rights are granted to others to serve San Jose Water Companyapstas customers recycled water, San Jose Water Companyapstas sales, revenue and operating results would be negatively impacted |
| o SJW Land Companyapstas expenses and operating results also could be adversely affected by the parking lot activities, the HP Pavilion at San Jose events, ongoing local, state and federal land use development activities and regulations, future economic conditions, and the development and fluctuations in the sale of the undeveloped properties |
| The San Jose Sharks, a professional hockey team, performs at the HP Pavilion |
| As a result of the cancellation of the 2004-2005 hockey season by the National Hockey League, SJW Land Companyapstas parking lot revenue was negatively impacted |
| The success of SJW Land Companyapstas real estate development strategy depends largely on ongoing local, state and federal land use development activities and regulations, future economic conditions, the development and fluctuations in the sale of the undeveloped properties, the ability to identify the developer/potential buyer of the available for sale real estate, the timing of the transaction, favorable tax law, the ability to identify and acquire high quality, relatively low risk replacement property at reasonable terms and conditions and the ability to maintain and manage the replacement property |