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SJW Corp. (NYSE:SJW)

Q4 2008 Earnings Call

February 26, 2009 1:00 pm ET

Executives

Suzy Papazian – Corporate Secretary

W. Richard Roth – President and Chief Executive Officer

David A. Green – Chief Financial Officer

Analysts

Heike Doerr – Janney Montgomery Scott

Michael Gaugler – Brean Murray, Carret & Co.

Christian Bradbury – Sidoti

Welcome to the fourth quarter 2008 SJW earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today’s call, Ms. Susan Papazian, Corporate Secretary. Please proceed.

Suzy Papazian

Welcome to the full year and fourth quarter 2008 financial results conference call for SJW Corp. Presenting today are Richard Roth, President and Chief Executive Officer, and David Green, Chief Financial Officer.

Before we begin today's presentation, I'd like to remind you that yesterday's press release and this presentation may contain forward-looking statements. We wish to caution you that these statements are just projections and that actual results and the timing of future events may differ materially.

For a description of factors that could cause actual results to be different from statements in the release and in this presentation, we refer you to the press release and to the annual report on Form 10-K filed with the Securities and Exchange Commission on March 10, 2008, and the report on Form 10-Q filed on November 6, 2008.

All forward-looking statements are made as of today, and SJW Corp disclaims any duty to update or revise such statements. You will have the opportunity to ask questions at the end of the presentation. As a reminder, this webcast will be available until May 5, 2009. You can access the release and the webcast at the corporate website, www.sjwater.com.

I will now turn the call over to Rich.

W. Richard Roth

I am Richard Roth, President and Chief Executive Officer of SJW. With me is our Chief Financial Officer, David Green. Together we are pleased to provide you with SJW’s fourth quarter and year to date results for 2008.

Additionally, I will discuss the general water supply situation in California, recent regulatory activity, our real estate business, acquisitions, capital activity and finally address any questions you may have.

Let me briefly summarize our 2008 results. For the 12 months ended December 31, 2008, SJW Corp earned $1.15 per diluted share compared to $1.04 per diluted share in 2007. Additionally, at their January meeting, the SJW Corp board of directors increased the annual dividend for 2009 to $0.66 per share from $0.645 per share in the previous year.

Water supply conditions in California are important to the company. As you know, precipitation levels affect San Jose Water Company’s water supply mix and water production costs. Accordingly, I’d like to give you an update on the current water supply situation in California.

In the last several weeks Northern California has received significant precipitation. However, the yearly precipitation levels remain below average for much of Northern California. There has been much discussion and speculation regarding the implementation of some form of enhanced water conservation or rationing in California.

However, in Santa Clara County there has been no final decision about any such restrictions. In the event of water use restriction the California Public Utility Commission will have significant authority over such rules, rates, structures and other important aspects related to how San Jose Water Company or other retailers would recover increased costs and any revenue lost due to mandatory restrictions.

Until the precipitation season typically ends around late March, it is difficult to predict whether any mandatory restrictions will be instituted. In any event, it is important to remember that the California Public Utility Commission and San Jose Water Company have effectively dealt with extended drought conditions in the past.

Our experienced and knowledgeable staff working with our regulatory counterparts are prepared to institute appropriate measures and communicate with our customers should enhanced conservation measures become necessary.

Turning now to regulatory affairs, in late November, Commissioners Peevey and Chong were both reappointed by Governor Arnold Schwarzenegger to another term on the California Public Utilities Commission. Both appointments are subject to state senate confirmation within 12 months and we look forward to continuing our work with these commissioners and their staff.

In late January, San Jose Water Company filed a general rate case covering rates for the years 2010 through 2012. In the application, we are requesting revenue increases of $36 million, $15 million and $20 million for the three years respectively.

We are proposing such increases to recover projected operating expenses and investments in infrastructure over the term of the general rate case. The infrastructure improvements such as water mains and well replacements, improvements to pumping stations and water tank upgrades throughout our 140 square mile service area are necessary in order to maintain safe and reliable water service to our customers.

A CPUT decision is expected in late 2009 with new rates going into effect in January 2010. On November 19, 2008, the long await proposed decision was issued in the first consolidated cost of capital proceeding involving California Water Service, California American and Golden State Water Company. The proposed decision authorizes a return on equity of 10.2% applicable to all three companies, but a final decision has not yet been issued.

On May 1st, San Jose Water Company is scheduled to file for a cost of capital determination for the years 2010 through 2012. In other recent rate activity, on January 1, 2009, the commission approved a revenue increase of $5 million for San Jose Water Company. This increase is pursuant to the company’s most recent general rate decision in November 2006 and is designed to recover projected operating cost increases for 2009.

On January 14th, our Texas subsidiary, SJWTX doing business as Canyon Lake Water Service Company, began billing at the rates reflected in our November 2008 rate filing with the Texas Commission on Environmental Quality.

Under the TCEQ rate case schedule, customer comments are permitted until March 14, 2009. We believe that the service and infrastructure improvements we have made in the Canyon Lake system have provided significant benefits for our customers and we are hopeful that the rates will be finalized soon after the comment period.

In late January, SJWTX completed the recently announced acquisition of the City of Bulverde service area. This transaction is important in several respects. It adds a large and growing service area to our operations. The number of connections added is nominal but the system is located adjacent to the northern boundary of the San Antonio water system and is directly in the path of growth for that region.

The transaction is indicative of SJW’s ability to work with public agencies in a cooperative and constructive manner. In addition to requiring TCEQ approval, it required separate agreements and approval from a river authority and municipality. The fact that we were able to complete this relatively complex transaction on a timely basis speaks to SJW’s ability, reputation and prospects for completing acquisitions in the future.

Before turning the call over to David, I’d like to address recent activity within SJW Land Company. In January, SJW announced that a large tenant had filed for Chapter 11 bankruptcy informed us of its intention to liquidate its business. The tenant still occupies the warehouse and office property in Knoxville, Tennessee and the rent is current. In the likely event that the tenant terminates the lease, we will seek to re-lease the property and have begun preparations for such an eventuality.

I’d now like to turn the call over to our Chief Financial Officer, David Green, for his detailed review of the results for the year.

David A. Green

I am pleased to present our results for the fourth quarter and the full year of 2008. As we’ve said throughout the year, the story in 2008 has been rate increases mostly offset by higher cost for water production and other operating expenses.

Basic and fully diluted earnings for fiscal year 2008 were $1.17 and $1.15 per share respectively as compared to basic and diluted earnings of $1.05 and $1.04 per share reported for the year ended December 31, 2007. The 11% increase in earnings was primarily due to a 7% increase in revenue supplemented by the sale of real property, which contributed an aggregate $1.2 million to net income and offset by a 6% increase in water production costs and operating expenses combined.

Total revenue was $220.3 million for fiscal year 2008, an increase of 7% or approximately $14 million compared to revenue of $206.6 million in 2007. Rate increases represented substantially all of the $14 million increase in revenue. We did not experience any material impact year-over-year due to changes in consumption.

At year end, we had 234,300 customers combined in both our California and Texas service areas representing an increase of approximately 1,000 over the customer count at the same time last year. The Land Company’s contribution to revenue was also essentially unchanged year-over-year at approximately $6.5 million. Dividend income from our investments contributed $1.3 million, which was also unchanged from last year.

Water production costs for the year ended December 31, 2008 were $90.2 million versus $86.3 million in 2007. Per unit cost for purchased water, which increased 7.8% and ground water extraction charges, which increased 9.5% were offset by a greater availability of surface water in 2008 compared to 2007.

All together, considering the increased per unit charges for purchased and pumped water, and the greater availability of surface water, average production costs per million gallons increased 4.5% to $1.7 million in 2008.

Total operating expense, including water production cost for the year ended December 31, 2008, was $187.5 million compared to total operating expense of $176.9 million in 2007. The increase was primarily accounted for by increases in production costs, maintenance expense, administrative and general expenses, depreciation, and customer service costs.

Net income for fiscal year 2008 was $21.5 million compared to $19.3 million in 2007. Also for the full year 2008, other comprehensive income reflecting or investment in California Water Service Group grew to $27.6 million from $17.1 million in 2007.

Briefly, fourth quarter results were as follows, revenue was $49.5 million versus $47.6 million in Q4 2007, an increase of 4%. The increase was attributable to $3.5 million in cumulative rate increases partially offset by $1.6 million in lower customer usage as compared to Q4 of 2007.

Fourth quarter net income was $4.2 million in 2008 compared to $3.8 million in 2007. Diluted earnings per common share grew 15% to $0.23 for the quarter ended 12/31/08 compared to $0.20 per share for the same period in 2007.

Water production costs for the fourth quarter of 2008 were $20.3 million versus $18.8 million for the same period in 2007, an increase of $1.5 million or 8%. Higher per unit cost for purchased water and ground water extraction charges contributed $1.4 million to the increase in water production costs.

Excluding production costs, fourth quarter 2008 operating expenses increased $842,000 compared to the same period in 2007. We also had approximately $300,000 in additional interest expense, but realized a $1.2 million gain in connection with divestitures of real property in the fourth quarter of 2008.

Utility plan investment for 2008 was $69 million compared to $73 million in 2007. At year end, our total outstanding interest bearing debt was $235 million, including $18.4 million on our short-term credit line. This compares to $221 million in interest bearing debt as of year end 2007. Interest expense grew $1.7 million to $14.7 million in fiscal year 2008 reflecting a full year’s interest expense and a 2007 vintage long-term debt plus a higher short-term debt balance.

In total, we are pleased with our financial results for 2008. Looking ahead, we believe that our 2009 investment plans are prudent and can be funded with internally generated cash flow, our credit line and continued reasonable access to capital markets. Further, we expect the future to be challenging with significant uncertainty on many fronts.

The current financial and economic strain is likely to bring on a structural shift and the beginning of a new secular trend. As investors, you should be confident that this management team is seasoned and ready to meet the challenge of change.

I’ll now turn the call back over to Rich for his closing remarks.

W. Richard Roth

Before we take your questions, I’d like to make a few comments about the capital markets and other recent events of significance. Attracting reasonable priced capital sufficient to satisfy SJW’s projected requirements may become more challenging as capital markets undergo significant changes and adjustments.

The key to SJW’s ability to attract capital at reasonable rates is a regulatory environment that sustains the regulatory compact, authorizes reasonable returns, and allows water companies to recover prudent capital investments. Through constructive, cooperative and transparent behavior, SJW has earned an excellent reputation with regulatory agencies.

Accordingly, while we expect closer scrutiny of all expenditures, we also expect regulators to continue to support the recovery of operating costs and reasonable returns on invested capital. The most recent capital activity at San Jose Water Company was in February 2009 when San Jose Water Company issued a $10 million unsecured note to a single institutional investor. The term of the note is 15 years with an interest rate of 6.54%. Although the term of this note is 15 years, the interest rate approximates San Jose Water Company’s recent long-term borrowings.

In the broader debt markets, it appears that while rates have decreased appreciably spreads have increased appreciably and capital markets in general remain in a dynamic state. In closing, SJW has two outstanding regional water systems, high quality real estate and other investments, and a strong balance sheet.

Our asset base and proven business model should allow us to navigate the significant structural changes occurring in the water sector and financial markets, and allow the company to continue to create shareholder value over the log-term.

Uncertainty and challenging times likely lie ahead, but as an SJW shareholder, you may be assured that a capable and motivated SJW team and an involved and committed board are prudently caring for your investment and seeking intelligent ways in which to grow shareholder value.

That concludes my remarks for today. Now I’d like to open the floor to your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Heike Doerr – Janney Montgomery Scott.

Heike Doerr – Janney Montgomery Scott

Couple of quick easy questions for you, I know that this proposed cost of capital decision for the three larger California utilities is taking a little longer than they had anticipated as they work to increase this allowed ROE. Does that throw off your May 1st timeline if they don’t have something wrapped up by then?

W. Richard Roth

No. We don’t believe it will.

Heike Doerr – Janney Montgomery Scott

How many companies are you filing with? You’ll go in tandem, right, and then they’ll get lumped into one?

W. Richard Roth

I think there’s about seven companies that will be in the Phase II proceeding or the second cost of capital proceeding.

Heike Doerr – Janney Montgomery Scott

The rate increase that you mentioned in Texas, can you give us what the amount is that you requested and how much you’ve put already into temporary rates?

W. Richard Roth

Well, in Texas the whole amount of the request goes into rates until such time as a determination is made that is or is not subject to further review by the TCEQ due to customer comments. The resulting revenue increase was about 14%.

Heike Doerr – Janney Montgomery Scott

Do you have that on a dollar basis?

W. Richard Roth

I don’t right now, but I’ll get it to you. It was around 750,000 or 800,000 somewhere in that range.

Heike Doerr – Janney Montgomery Scott

David, if we think about pension expense and the cash contribution you expect to fund in 2009, can you maybe talk about where we are relative to where you guys had anticipated we would be?

David A. Green

Heike, with the equity market performing as they did last year, we all know that the asset portfolios have taken a significant hit. We’ve got quite a bit of our assets in bonds, which weren’t impacted as much. That said the expense is certainly expected to go up quiet a bit in the greater than 50% range. The cash contribution, however, will not change all that dramatically from last year. In the past we had over contributed, which kind of helped cushion the blow.

Heike Doerr – Janney Montgomery Scott

But if we think about this roughly $5 million, I believe, of increased rates that we’re going to see, is that baking in the pension expense? Where are you relative to the assumptions that were put into rates?

David A. Green

Well, the $5 million increase is just one of the areas where we’ll see revenue increase. There were some mid-term, should I say, allowances for additional revenue. So we’re certainly expecting greater than the $5 million number, and the rate case was determined three years ago as well. The increase in pension is much more near-term event, which really no one anticipated.

W. Richard Roth

Heike, let me try and add some color to that. I think it’s safe to say that the way in which the expense calculation is determined is a little bit different for rate making. As you know, that’s considered a liability and then a regulatory asset is recorded to offset that. So when it comes to the actual expense that flows through the income statement, if that’s your question.

Heike Doerr – Janney Montgomery Scott

Yes. When we think about the rate case that you recently filed, can we assume that you’ve taken into account the current economic situation and what stocks are doing now so that that rate case accurately reflects the current economic climate?

W. Richard Roth

Yes. As much as we know today, yes, it does.

Operator

Your next question comes from Michael Gaugler – Brean Murray, Carret & Co.

Michael Gaugler – Brean Murray, Carret & Co.

Rich, I was hoping maybe you could give us a little more color on your water supply situation coming into the summer months. I know the Delta smelt is a topic that’s near and dear to your heart and how that could potentially play out for you as you look forward into the heavier flow season.

W. Richard Roth

Okay. Well, locally here rainfall is just as little bit below normal. It’s about an inch below normal. Statewide I would say that that’s probably about the same situation here that we’re approaching normal year-to-date rainfall levels. Locally the reservoirs here in the San Jose and Santa Clara County area are at about 60% of normal. I think the actual number is 56% of normal. And we’re still in the rainfall period here, which should end probably the middle to end of March.

And there’s a significant amount of snow pack in the sierra’s and so forth, but I think you identified correctly some of the issues that are affecting us on a larger basis and that is cutbacks or potential cutbacks, and deliveries from the Bay Delta and accordingly gives us state and federal water projects and those are still in a fluid state.

But I think there’s also some political jockeying going on that I think, in order to find a fix or get a fix for the Bay Delta, there’s been a little bit of politicking going on to create certainly a heightened awareness that we need to get something done in California to fix the Bay Delta system. And I think that we are actually making progress in that regard.

So I think it’s probably a little bit too early to say what the impact is going to be and what steps will be taken. But suffice it to say that it is definitely on everybody’s radar, including the elected officials and water agencies and I think the best thing is just to stay tuned.

Operator

Your next question comes from Christian Bradbury – Sidoti.

Christian Bradbury – Sidoti

I was wondering, is there any concern that the economic situation in California could have an affect on future rate increases?

W. Richard Roth

I can’t say no to that because so far it hasn’t and it gets to the statement I made about regulators sustaining the regulator compact, and I believe that it would take a significant departure from where we are or a significant event for us to depart too far from where we are now in terms of regulators supporting investments and infrastructure. There are certainly needed.

I think we have very aware group of commissioners as well as their staff, but there’s all sorts of thought potential political hurdles to clear. But I do think, and I believe this is a fairly widely held opinion, that the regulators in California certainly understand that we have to do this. And I think it also is an important investment in infrastructure and I think they recognize that.

I don’t mean to speak for them but I do think that they are going to be very careful scrutiny of all operating expenses and capital projects. So I just think closer scrutiny is probably the takeaway.

Christian Bradbury – Sidoti

Also I guess looking at the other side a lot of municipalities in California are facing some financial challenges. Are you seeing any opportunities to private side surrounding systems?

W. Richard Roth

Well, I think the other shoe is yet to drop. As lower income tax, sales tax and property tax revenues roll through the system, which will take some time, and increasing pension obligations and a decline in the stock market. As all those events kind of converge and we see the real impact, I think the one distinction I’d like to make is I think we’re aware of that situation and know what’s going on.

I’m not so sure that some of our counterparts and public agencies are as aware but that will work its way through and I think for the time being we aren’t seeing any real significant movement. But that may or may not occur, and of course, there are some stimulus funds that will flow to California. And we’re trying to pursue low cost financing through the state revolving fund and make sure that the affordability of all our capital projects is as good as it can be.

Christian Bradbury – Sidoti

I think I might have missed this, what are your future plans for the Knoxville property?

W. Richard Roth

We still have a tenant in the property and I think it’s fairly clear that they are going to liquidate and we’ve already been to Knoxville and are seeking out new tenants, and we believe strongly that it is a very good property. These are difficult times but think it’s a very good property and we’re actively marketing the property and attempting to re-lease it.

Operator

There are no further questions at this time. I would now like to turn the call back over to management for closing remarks.

W. Richard Roth

I want to thank everybody for their support and investment in SJW and I want you to all know that we are very aware of the seriousness of the situation and that we are taking the steps necessary to run our business as efficiently as possible, and to make sure that all the services and goods that we procure that the contracts that underlie that procurement are being examined and that we’re taking every step we can to operate as efficiently as possible.

So we look forward to you continues support and investment and look forward to talking to you next quarter.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Have a great day.

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Source: SJW Corp. Q4 2008 Earnings Call Transcript
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