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SJW Corp. (NYSE:SJW)

Q4 2007 Earnings Call

February 21, 2008 1:00 pm ET

Executives

Suzy Papazian – Corporate Secretary, Attorney

Richard Roth – President, CEO

Angela Yip – CFO

Analysts

Michael Gaugler – Brean Murray, Carret & Co.

Bill Garrison – Ironworks Capital

Operator

Good day ladies and gentlemen and welcome to the SJW fourth quarter 2007 results conference call. My name is Nikita and I will be your coordinator for today. At this time, all participants are in a listen only mode. We will be facilitating a question and answer session towards the end of the conference at which time you may press star one to ask a question. If at any time during the call you require assistance, please press star followed by zero and a coordinator will be happy to assist you. I would now like to turn the presentation over to your host for today’s call, Ms. Suzy Papazian, Corporate Secretary and Attorney, please proceed ma’am.

Suzy Papazian

Thank you operator, welcome everyone to the full year and fourth quarter 2007 financial results conference call for SJW Corp. Presenting today are Richard Roth, President and Chief Executive Officer and Angela Yip, 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 10K filed with the Securities and Exchange Commission on March 9, 2007 and reported on form 10Q filed on November 2, 2007. All forward looking statements are made as of today and SJW Corp disclaims any duty to update or revise this statement. You’ll have to opportunity to ask questions at the end of the presentation. As a reminder, this webcast will be available until April 29, 2008. You can access the release and the webcast at the corporate website, www.sjwater.com. I will now turn this over to Rich.

Richard Roth

Thank you Suzy, good morning and thank you all for joining us today. I’m Richard Roth, President and Chief Executive Officer of SJW and together with our Chief Financial Officer, Angela Yip, I am pleased to provide you SJW’s fourth quarter and year to date results for 2007. Very shortly I will turn the call over to Angela for a more detailed discussion of our financial results. In 2007, SJW was challenged by significantly reduced water supplies which increased our dependence on higher cost purchased water. This as Angela will explain in more detail is reflected in the fourth quarter and full year result.

What may not be evident in 2007’s results is the underlying strength in key financial fundamentals at SJW. For the first time in the company’s history, revenue exceeded $200 million, totaling nearly $207 million in 2007 with a four year 2003-2007 compound annual growth rate of 8.25%. Operating income dropped in 2007 but only marginally, showing a strong four year compound annual growth rate of 6.42%. Utility plant and real estate investments net of depreciation and amortization approximate $645 million at 12/31/07 with a four year compound annual growth rate of nearly 10%. So as you can see, SJW continues to build a strong financial base for future earnings.

Also I wanted to speak briefly about the impact on water supplies to the state and Federal water projects in California as a result of recent court rulings aimed at protecting endangered species in the Sacramento-San Joaquin River Delta. Basically, deliveries to the state and Federal water projects may be reduced by as much as 10% during dry years and by as much as 35% during wet years. I am sure you are all interested in what this means to SJW.

What I can tell you is that in 2008, SJW expects to receive full contract deliveries from the Santa Clara Valley Water District, our primary water wholesaler. Any temporary reduction in contract deliveries will be offset through increased ground water protection which will increase pumping and energy costs. San Jose Water Company and its customers are likely to incur higher wholesale water rates from the Santa Clara Valley Water District as the district experiences lower revenues and increased costs to provide alternative supply. The specific long term impacts of any reductions in pumping from the Bay Delta are difficult to predict at this time. Much more will be known about the short term when final information regarding snow pack and precipitation levels are known in late Spring and as events of the Summer unfold. I will now turn the call over to Angela for her report. Angela.

Angela Yip

Thank you Rich and good morning everyone. As Rich mentioned, 2007 was a challenging year, low rainfall levels and the consequent reduces availability of surface water during the winter months represented the biggest impact on our results. That said, we did see increase of revenue year over year and our administrative and general expenses were well controlled. I would like to talk about the full year 2007 first. Basic and fully diluted earnings for the full year 2007 were $1.05 and $1.04 per share as compared to basic and diluted earnings of $2.11 and $2.08 per share reported for the year ended December 31, 2006.

[Rich remembered] that income in 2006 reflected a contribution from the sale of non [mutually] property of $16 million or $0.89 per share. Without the gain on sale of properties in 2006, earnings would have been $1.22 per basic and $1.19 per diluted share. The decrease in year to date earnings was primarily due to the increase in production costs and operating expense offset by the increase in operating revenue. Total operating revenue was $207 million for the year 2007 an increase of about $17 million compared to revenues recorded in 2006. [Were] increases contributed $10 million to revenue, increases in consumption and new customer connections added since a year contributed about $5.8 million. [Land company] revenues reflect an increase of $2.2 million due to our [professes] in generating revenue from the real estate portfolio. I would now discuss the production and other operating expenses in detail.

Our water production cost consists of purchased water, power and ground water extraction charges. In 2007, water production costs increased by $17.5 million attributable to our spending approximately $8.7 million in substituted water to make up for decrease of service water supply. Increase of water demand, higher costs for ground water extraction, higher purchased water prices and higher energy consumption accounted for the remaining increase in water production costs. Water production costs in 2006 represented approximately 36% of utility services revenue and in 2007 water production costs represented 42% of such revenue.

[True] impact of budgeting and cost control, SJW Corp was able to contain the growth of other operating expenses. Total other operating expenses excluding income taxes increased to $4.4 million compared to 2006, primarily attributable to increase operating expenses from acquired systems, increase in maintenance expenses due to [holiday] repairs through the year, increased administrative and general expenses due to higher salaries, pension and benefits and increased depreciation expense primarily attributable to [added] utility plant improvements.

As I have mentioned previously, our revenue growth has outpaced the rising expenses thanks to our continuous effort in cost control. Income tax expense decreased $2.7 million in 2007, compared to 2006, due to lower operating income. Net of tax, other comprehensive loss of $2.2 million was due to a decrease in the market value of our investment in California Water Service Group. Now I would like to briefly touch on the fourth quarter operating results. Revenue in the quarter was $47.6 million compared to $44.5 million a year ago.

[Rate] increases contributed about $2.7 million to revenue in the fourth quarter of 2007 in comparison to the same period of 2006. Our [land] company revenue was higher by approximately $459,000 compared to a year ago due primarily to additional rental income from [new] properties. Production costs increased to $18.8 million in the fourth quarter 2007 in comparison to $15.9 million in 2006, primarily due to the reasons previously sighted. So the other operating expenses for the fourth quarter, excluding income taxes increased by $983,000 in comparison to the same period in 2006 reflecting some successes of our cost control effort.

Now I would like to draw your attention to the fact that our corporate earnings and financial reports are based on the entire diversified economic asset base, including our regulated and non regulated businesses and our investments. In our regulated business, the water utilities services invested capital generally referred to as rate based is comprised of the company’s utility assets and working cash, reduced by capital provided from developers and by deferred taxes. Rate based included invested capital from the shareholders as well as from the lenders.

We measured the operating results against the shareholder’s funded equity capital in 2007 and the water utility services achieved a return on equity which approximated the return authorized by our economic regulators. The authorized return on equity in 2007 from the California Public Utilities Commission where SJW Corp derives the majority of this revenue was 10.13%. SJW Corp [unintelligible] portfolio is 100% of these and it generates cash flow from operations which exceed its reported operating results due to non cash operating expenses like depreciation.

[The real equity] portfolio generates a return on cash flow commensurate with the risk and return on comparable properties. In 2007, SJW Corp deployed more than $120 million in developing utility plant assets and real estate investments. Over the last ten years of capital investment in utility plants have increased an average of 8% annually. The utility asset become rate based and are positioned to generate future earnings growth. Our real estate investments [deployed, unintelligible] tax advantage sale of property is generating cash flow and net income to SJW Corp and help supporting a healthy sustainable dividend growth of 7% to our shareholders in 2007. In addition to this record investment of cash, SJW Corp [opposed] a healthy payout ratio of approximately 50% utilizing internally generated sources to fund our capital expenditure program and future earnings growth while maintaining a strong balance sheet.

To sum up the results for the year, we are pleased that these factors within our control continue to be managed effectively and efficiently and we are able to serve our customer’s needs during times of [false] abundance and scarcity of water. Our operations throughout SJW Corp will continue to focus on increasing efficiency. This concludes the financial portion of this call, now I would turn the call back to Rich Roth, our President and CEO. Rich.

Richard Roth

Thank you Angela, well as you can see from Angela’s report, SJW Corp delivered another year of solid earnings and growth in 2007. SJW’s flagship utility San Jose Water Company turned in a strong performance in spite of an extremely dry winter and minimal surface water supplies through effective budgeting and cost controls, San Jose Water Company was able to earn its authorized rate of return and contribute significantly to consolidated earnings. SJW land company’s operating income from cash flow increased significantly in 2007 with the addition of nearly $50 million in new real estate investment.

With the new investments, SJW land company’s real estate portfolio grew to nearly $85 million with operating revenue of approximately $6.5 million. All of SJW land company’s real estate investments are fully leased and performing as planned. SJW [2 E T X] Inc, SJW’s regulated Texas Subsidiary, continued to perform according to plan by improving operations, water quality, water supplies and customer service. After holding rates constant for nearly two years while making key operational improvements, the company has successfully sought and received rate relief in 2007.

Our approach of seeking rate increases only after having delivered on our commitments has proven successful in gaining the trust and respect of customers and regulators. SJW’s commitment to growing its asset base was evidenced in 2007 by the investment of over $120 million in utility plant and real estate. SJW’s ability to fund this level of capital expenditures without issuing additional equity demonstrates the company’s financial strength and disciplined financial management.

In January of 2008, SJW announced a nearly 7% increase in its annual dividend. SJW’s strong balance sheet and ability to navigate the significant structural changes occurring in the water sector and financial markets have allowed the company to sustain meaningful increases in our annual dividend. SJW’s disciplined approach to managing the dividend payout ratio has allowed the company to consistently reinvest a substantial amount of earnings in rate base while increasing the cash dividend at a rate which exceeds inflation. As I previously mentioned, enhanced concerns over climate change and the environment are testing SJW’s operating model. In late 2007 the Federal court mandated reductions in deliveries from the San Francisco Bay Delta to the state and Federal water projects that provide drinking water to nearly 23 million Californians.

Although the impact of reduced water deliveries is not fully known, it is not expected to substantially impact SJW in 2008. It is imperative that California immediately develop and implement sustainable measures to ensure that the long term water supply needs of the state are met. It is becoming increasingly clear that SJW must also adapt to structural changes in the price and availability of energy and key construction materials. Changes are being made to SJW’s operations and practices in order to optimize the efficient use of energy, petroleum products and other materials.

SJW’s regional approach to the water business allows us to achieve a more efficient and environmentally conscious business model by concentrating resources within our regional platforms, avoiding the relatively high cost structure of managing many geographically disparate water systems. SJW’s stock is not immune to broader market movements, but SJW’s shareholders can be assured that their investment is supported by a growing base of income producing assets, a robust balance sheet, a capable and committed workforce and an involved and motivated Board. That concludes my remarks for today, I would like to open up the floor to your questions. Operator.

Question-and-Answer Session

Operator

Ladies and gentlemen, if you wish to ask a question please press star followed by one on your touchtone telephone. If your question has been answered or you wish to withdraw your question, press star followed by two. All questions must be submitted at this time. Questions will be taken in the order received. Press star one to begin and please stand by. And your first question comes from the line of Michael Gaugler of Brean Murray, Carret, please proceed sir.

Michael Gaugler – Brean Murray, Carret & Co.

Good morning Rich, good morning Angela, couple questions. First maybe you could add a little color Rich on your forward outlook based on the significant rainfall and snow that’s occurred in California and perhaps what that could do to your supplies in the summer months.

Richard Roth

Yeah I think, good question Michael but what the state was going to do is probably take a really close look at the end of March at snow levels and precipitation levels and make their final determinations at that point. I think that it’s probably a little bit too early to say exactly what impact it will have on deliveries to the state and Federal water projects and consequently on the rates that will flow through that system to wholesalers and retailers. But suffice it to say at this point that certainly additional rainfall and snowfall is going to help the situation dramatically but we’re still facing, we’re still facing some uphill battles here but I’m happy to report that it’s raining in San Jose right now.

Michael Gaugler – Brean Murray, Carret & Co.

Good. Are you getting any feedback from the Public Utility Commission as to how they’re viewing this as the situation unfolds and how accommodative or unaccommodative they’re going to be?

Richard Roth

Well I think that they’re going to be fairly accommodative. You know, I think it is a fairly straightforward situation that we have to deal with here and I believe that the Commission is well aware of the situation and are going to treat us justly and appropriately. I think that you know a lot of the rate increases that may happen, I’m not saying they will happen, but may happen because of structural shortages in water and the need to cover fixed costs by wholesalers and state and Federal water projects, I think that it’s been clear in the past that they’ve demonstrated a willingness to allow us to pass those costs along. So and also I think it’s safe to say that the Commission is you know certainly looking at as you’re probably all aware under the Water Action Plan and other proceedings that you know the potential decoupling of revenue and conservation based rates and all of that will play into the ultimate solution. Or the way in which they address it.

Michael Gaugler – Brean Murray, Carret & Co.

Alright and if you don’t mind, just two more quick questions. Wondering what you’re seeing in the acquisition pipeline, both on the real estate side and on the utility side.

Richard Roth

Well I think on the real estate side we’ve you know we’ve converted a lot of our non income producing assets into income producing assets and you know certainly last year our 2006 sale of our downtown properties here to Adobe Systems was a major event for us. So, unlikely that that will be repeated again because we just don’t have that kind of property or that valuable a property in our non income producing asset inventory.

But we have, you know we’ll continue to work as we have in the past and we still have some ways to go there and looking forward to that but I think a lot of the growth we’ve experienced will probably, it won’t be like in the past. And on the acquisition front, in the water utility, our Texas operation is doing well. We’ve signed a couple contracts to acquire systems down there, they are proceeding through the TCEQ which is our economic and environmental regulator in Texas and you know we’re quite optimistic but I can’t at this time speak about any specific actions we have underway.

Michael Gaugler – Brean Murray, Carret & Co.

Okay and the last question, are you seeing any movement from the opposition in terms of the logging situation? Do you get a sense that they’re going to actually let you clear some of that away to keep the fire, the potential for fire down or are you still seeing a lot of push back there?

Richard Roth

Gee I’m sure glad you asked that question Michael.

Michael Gaugler – Brean Murray, Carret & Co.

I was reticent to ask this because I know it’s a touchy subject.

Richard Roth

Well as you know, our application for a non industrial harvest, timber harvest plan has been denied and we’re seeking a hearing on that and we’re also, we’ve requested some information regarding the calculations that underlie their denial of our application. So stay tuned Michael, we’re still seeking a date for a hearing on our request for a rehearing of our application and we’ll keep you posted as soon as we know more but no real new development at this point.

Michael Gaugler – Brean Murray, Carret & Co.

Okay listen I got a follow up, just kind of occurred to me while you were answering my question, if a fire starts in your watershed area, do you bear and responsibility for that?

Richard Roth

I’m not an attorney and I really don’t know how to react to that question, I mean I don’t think so Michael, you know I guess there’s 1,000 permutations that it could occur in a situation like that but we don’t think so, they’re usually acts of God or acts of nature and unless we actually started the fire ourself I don’t think we’d bear any responsibility.

Michael Gaugler – Brean Murray, Carret & Co.

Okay, good, the reason I ask is I remember when you started going through this logging, potential logging permitting process, you know that some of the growth there hadn’t been trimmed back for, I don’t remember if it was decades or the better part of a century and you know over that kind of a time period it really probably wouldn’t take much to get something started in a dry season.

Richard Roth

Yeah well I think we’re very attuned to that and we need to certainly be aware of it but we’re doing our best Michael and we’ll keep you posted and you know we’re going to manage our watershed very responsibly.

Michael Gaugler – Brean Murray, Carret & Co.

Alright, thanks Rich.

Operator

Your next question comes from the line of Bill Garrison of Ironworks Capital, please proceed sir.

Bill Garrison – Ironworks Capital

Hi guys, thank you. Wanted to see if you were, I wanted to ask if you were able to adjust the weather conditions in the fourth quarter and I guess I’m interested in trying to learn about what the consumption trends are and I’ve realized you’ve had a positive numbers side added in the press release but I guess it seems like that is going to be quite thin then on the precipitation levels and wanted to see if you could just add any insights to that.

Richard Roth

Well I think that what we’ve seen over the course of many years here is sort of that conservation does have an impact on usage and certainly the weather patterns do and I know that’s fairly obvious so I apologize for that but total production in 2007 in million gallons or let’s say a billion was almost 52 billion compared to 49 billion in 2006. So you know we have, the weather does have an impact, growth has an impact but I don’t see at least right off the top here that you know all of the dialogue and discussion and media coverage of water supplies has radically changes as customer’s habits, consumption habits. Now I think it’s fairly clear having said that that we’re going to have to make some changes and I think that most citizens are willing to do that but also you know we need to develop some new supplies and find ways to solve the situations we face. But again, historically looking back and at least through the end of 2007 we haven’t seen any radical changes in consumption patterns.

Bill Garrison – Ironworks Capital

Okay, secondly, would you be able to help me get a better understanding of the relative difference in cost to you between your ground water and your purchased water? Again I see numbers quarter to quarter but I guess as I look at the entire year, can you help me think about that in terms of relative cost position?

Richard Roth

Yeah I’m going to turn that over to Angela, I think she’s best prepared to answer that question.

Angela Yip

I think it’s important to understand that the purchased water costs and the ground water costs are basically set by the Santa Clara Valley Water District. The California Public Utilities Commission provide a mechanism for some of the water company to pass through some of the cost increases. So in a different way, the cost increases from the district were able to receive rate increases from the customers to offset them and so to the extent that if we are not able to.

The only opportunity we are not able to receive the cost offset is that the change in the make. So, of course at the same time you would think the cost fluctuates because of the use of the service water, if we, in the rate case setting we do have a set amount of service water that the CPUC expect the company to receive and to the extent that we did not receive that service water amount, cost will have to be the factor because we’ll have to buy the substitutable water to provide the demand to the customers.

Bill Garrison – Ironworks Capital

Okay, alright yeah I guess I just need to work with the numbers a little bit more.

Richard Roth

Why don’t you call Angela offline if you would, it’s probably a very fair question and I think that you know I’m not going to say that our surface water supplies are free, but certainly they are radically different in cost than our purchased water and our pumped water and to the extent that we don’t receive surface water has a [greaty] impact and our 10K will be issued here very shortly and it really sets forth in stark detail what the differences are but you can also see in the press release that production costs went up dramatically even though the usage did go up but also production costs went up disproportionately because of the lack of surface supply. So to drill down into that a little bit more, that’s probably best to go offline and call Angela.

Bill Garrison – Ironworks Capital

Okay, lastly, is it too early to get a read on likely capital expenditures for 2008?

Angela Yip

The capital expenditure amount will be disclosed in our 10K and we will be issuing the 10K within ten days or so.

Bill Garrison – Ironworks Capital

Okay, very good, thank you.

Operator

Once again ladies and gentlemen to ask a question press star one. There are no further questions at this time. I will now turn the call over to SJW for closing remarks.

Suzy Papazian

Thank you for joining us today, we look forward to talking with you when we report on our first quarter 2008 results. Thank you.

Operator

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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