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SJW Corporation (NYSE:SJW)

Q1 2008 Earnings Call Transcript

May 1, 2008 1:00 pm ET

Executives

Suzy Papazian – Corporate Secretary and Attorney

Richard Roth – President and CEO

Angela Yip – CFO and Treasurer

Analysts

Michael Gaugler – Brean Murray Carret

Heike Doerr – Janney Montgomery Scott

Bill Garrison [ph] – Iron Mark Capital

Operator

Good day, ladies and gentlemen, and welcome to the SJW Corp. first quarter earnings conference call. My name is Michelle and I'll be your coordinator for today. At this time, all participants are in listen-only mode. We'll be facilitating a question and answer session towards the end of today's conference. (Operator instructions) As a reminder, this conference is being recorded for replay purposes. I'd now like to turn the call over to your host for today, Ms. Suzy Papazian, Corporate Secretary and Attorney. Please proceed.

Suzy Papazian

Thank you, operator. Welcome, everyone, to the first quarter 2008 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 its presentation may contain forward-looking statements. We wish to caution you that these statements are just predictions 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. All forward-looking statements are made as of today, and SJW Corp. disclaims any duty to update or revise such statements. You'll have the opportunity to ask questions at the end of the presentation. As a reminder, this webcast will be available until July 22, 2008. You can access the release and the webcast at the corporate website, www.sjwater.com.

I'll now turn the call over to Rich.

Richard Roth

Thank you, Suzy, and thank you all for joining us today. I'm Richard Roth, the President and Chief Executive Officer of SJW. Together with our Chief Financial Officer, Angela Yip, I'm pleased to provide you with SJW's 2008 first quarter results.

I'll begin with some operational highlights and then turn the call over to Angela for a more detailed discussion of our financial results. Also, during this morning's call, I'll speak more globally about SJW Corp., as a company, and as an investment. I've spoken to you before about SJW's strong balance sheet and diverse and growing asset base. I think it is equally important to share perspectives on our operating strategies and how these have created value for our shareholders.

First, the highlights. Weather, of course, is one of the most significant factors impacting the water utility business. More rainfall means greater availability of surface water, but generally results in lower consumer demand. Dry weather means less surface water and can result in higher expenses for ground water pumping and higher cost purchased water. For the past 140 plus years, SJW has adapted its operating strategies to accommodate varying weather conditions, assuring reliable water service for its customers and focusing on earning our authorized return on equity. The first quarter of 2008 provided some relief from the dry weather that we experienced in 2007.

The Sierra Nevada snow pack, which is the primary source of water for much of California, returned to near normal levels and 2008 has not been declared a drought year by the California State Department of Water Resources. Although local rainfall and surface water storage level during the first quarter were lower than the five year averages, they were higher than the first quarter of 2007, resulting in lower water production costs on a quarter-over-quarter basis. Angela will be providing you with additional information shortly.

Rate increases were received for both San Jose Water Company and SJW TX, our Texas regulated utility operation. The Texas rate increase was implemented in December 2007 while we wait a final approval from the Texas Commission on environmental quality. In California, the rate increase became effective in early January. We saw continued growth in our Texas customer base and service area, while both our regulated operations improved their financial performance over the same period last year. San Jose Water Company is nearing the completion of an extensive facilities reorganization including an overhaul of our information technology backbone and platforms. These projects will improve communications, enhance customer service, and increase efficiency through superior resource utilization.

We've also taken steps to further reduce SJW's energy and resource consumption by carefully reviewing and revising energy and raw material utilization. By formally instituting a green company program, we've established goals aimed at reducing waste and implementing cost effective green technologies such as the use of photovoltaic generation systems, hybrid vehicles and other best practices.

Recognizing the need for an increased commitment to water supply challenges and the associated opportunities, SJW has refocused top engineering and operations talent on the development of recycled water and other alternative forms of water supply. So as you can see, SJW continues to transform itself to keep pace with the rapidly changing business conditions and resource challenges.

I'd now like to turn the call over to Angela for her report. Angela?

Angela Yip

Thank you, Rich, and good morning, everyone. As Rich mentioned, with the experience relating from dry conditions during the first quarter, water demand was lower than last year's first quarter and this, combined with improved surface water supply, meant that lower water production costs were the theme this quarter.

In the first quarter of 2008, total operating revenue was $41.3 million, an increase of 6% compared to $39 million in the first quarter of 2007. For the quarter, net income was $2.7 million compared to $2.1 million for the same period in 2007. Basic and fully diluted earnings were $0.15 per share compared to $0.12 and $0.11 per share, respectively, for the same period in 2007. Rate increases were the key impact on revenue in the first quarter combined with the increase in revenue from our steadily growing customer base. We also saw increase in revenue from real estate.

Rate increases and new customer connections contributed about $2.7 million to revenue. Our land company revenue was higher by $257,000 compared to a year ago. Consumption was lower by approximately $618,000 versus a year ago.

Finally, other revenue was lower by about $111,000 compared with the same quarter in 2007. As I've mentioned, water production costs were lower this quarter versus the year ago. Though unit costs for purchased water were higher, increased surface water supply combined with lower usage led to an overall decrease of $326,000 in total water production costs in the first quarter of 2008 compared to the same quarter in 2007. The factors leading to this decrease included $922,000 less spent on substitute of purchased water and $300,000 savings due to lower usage. These savings were partially offset by ground water extraction charges, purchased water unit cost, and energy cost higher by $896,000 in the first quarter of 2008.

As I've mentioned previously, a key focus for us is cost control. Our regional operating platform helped in this aspect because of transparency throughout the organization. In the first quarter, total operating expense increased less than 1% in comparison with the same quarter of 2007. General and administrative expenses, non-income taxes and other expenses were comparable to the same period last year. Our maintenance expense was up marginally over a year ago, an increase of $252,000. Income tax expense increased by $380,000 in the first quarter compared to the same quarter last year due to higher income. Based on improvements we've made to the water company plants and increases in our land company property portfolio, depreciation and amortization expense increased $451,000 in the quarter. Net of tax, other comprehensive income of $733,000 in the first quarter 2008 was due primarily to changes in the market value of our investment in California Water Service Group.

SJW Corp.'s real estate portfolio is 100% leased and we generate cash flow from operations which exceeds its reported operating results due to non-cash operating expense like depreciation. The real estate portfolio generates a return on cash flow commensurate with the risk and return on comparable property. Our investment in land and Cal Water provide cash for our growing dividend, putting our assets to use in our shareholders' interest without requiring a great deal of active management.

During the first quarter, we concluded negotiations with our unionized work force and one key step for us was to convert our defined benefit retirement plan into a cash balance retirement plan for new hires, which makes our retirement plan expense more predictable in the future, reducing the company's pension liability risk in this legacy cost, while continuing to provide a competitive, secure and enhanced benefit to our employees.

To sum up the results for the first quarter, we were pleased that those factors within our control were managed effectively. We continue to be able to provide excellent customer service and high quality water during times of both abundance and scarcity of water while providing a robust payout ratio to our shareholders.

This concludes the financial portion of this call and now I'd turn the call back to Rich. Rich?

Richard Roth

Thank you, Angela. As you heard from Angela's report, SJW Corp. delivered another solid quarter of earnings and growth. I want to emphasize that we managed SJW for the long term, rather than on a quarter-to-quarter basis. Weather cycles and rainfall do impact short-term results; however, SJW operates on a proven model and a sustainable durable philosophy which grows our capital base and optimizes our earnings potential. Our choice of business platforms and operating strategies are reflected in that model and our ability to execute is demonstrated by our track record of consistently achieving above industry average ROEs in our regulated water utilities.

It may be useful to be a bit more specific as to how our business model and operating strategies have evolved and translate it into results for our shareholders. As you know, the water utility business is extremely capital intensive. At SJW, we've demonstrated that effective capital management is a core competency and that we indeed have the ability to improve results, service levels, and system reliability. Three factors are key to our success – regional platforms, a sustainable financial model and regulatory effectiveness.

Regional platforms, SJW has a proven operating strategy for our regulated utility business, establishing solid regional platforms in both California and Texas. These platforms allow us to efficiently deploy large capital investments and achieve economies of scale. Because the customer base is larger and more concentrated, the larger capital investments generally result in lower rates than those of smaller disparate systems. Regional platforms facilitate organic growth and allow efficient integration into our existing operations of tuck-in or bolt-on acquisitions. The regional scope of our operations eases staffing, supports the cost of outstanding management, and affords us the discipline and control to keep expenses in check. But most importantly, our customers benefit from high quality service and reasonable rates.

Sustainable financial model, SJW employs a sustainable financial model balancing payouts to shareholders with a growing need for investments in our utility operations. At SJW, we consistently demonstrated an ability to generate sufficient internal capital to meet our needs without additional equity offerings which may dilute shareholder value. The cash flow generated by SJW Land Company and our other investments contributes to the company's consolidated dividend growth and provides additional capital with which to grow the company.

Regulatory effectiveness, of course, our regulated water utilities are the core business of SJW, and regulatory effectiveness, or the ability to achieve authorized rates of return, is one of the keys to creating shareholder value. Our approach to regulation is similar to our operating philosophy: Create customer satisfaction with outstanding service, invest wisely, and pursue fair and reasonable rates. For example, in planning our infrastructure improvements over the past 10 years, we've established criteria to guide us in prioritizing projects and maximizing customer benefits.

We leverage our in-house engineering and operations expertise, analyze leak history and other operating data and employ technologies to plan, substantiate and pursue fair regulatory treatment for our investments. We've made it a priority to understand and be effective in the regulatory process. We actively participate with our regulators and proceedings in educational forums to tackle tough problems and exchange ideas. Ultimately, of course, our excellent reputation with California Public Utility Commission and the Texas Commission on Environmental Quality has been earned on our outstanding customer service, environmental compliance, and cogent well substantiated regulatory filings. What this has meant for SJW is a track record of timely rate recovery and an opportunity to earn above industry average returns.

There are, however, significant challenges to the water industry posed by rising energy costs and other economic pressures. Costs are simply going up and rates are not infinitely elastic. SJW is taking specific measurable steps to address these challenges. One example that I've already shared with you is SJW's green company program. During the first quarter, we continued our pilot project generating electricity from photovoltaic cells installed on the roof of one of our large reservoirs. The site produces enough energy to power 75 homes but we are using the electricity on site to offset our purchased power at this location. We look at green technology not only from an environmental and corporate ethics point of view, but as a way to control costs.

Another example is in the area of human resources. The company and our unions have been working together to address the impacts of rising legacy costs or the cost of post-retirement benefits. As Angela mentioned in her comments, during the first quarter of 2008, negotiations were completed to transition to a new cash balance retirement plan and phase out the existing defined benefit plan. This should prove to be an effective tool in managing legacy costs. I spoke briefly last quarter about the impact on water supplies of recent court rulings aimed at protecting endangered species in the Sacramento, San Joaquin River Delta. Those rulings suggested that water deliveries to the state and federal water projects may be reduced in future years depending on rainfall or water supply conditions.

In 2008, San Jose Water Company expects to receive full contract deliveries from the Santa Clara Valley Water District, our primary water supplier. We also have the groundwater supplies and pumping capacity to offset any temporary reductions in contract deliveries. And we are authorized balancing accounts that allow us to recover price increases in groundwater extraction charges and purchased water costs. Although everyone in the state will be impacted by the decisions made to protect the Delta, we believe that SJW will be able to deal with those decisions effectively and that the regulatory regime in California will continue to provide opportunities for us to recover the costs of doing business and earning a fair rate of return on invested capital.

We are not waiting for water supply solutions to come to us. We're actively seeking alternative sources of supply including opportunities to expand the use of recycled water in our service territories.

In closing, we believe that our proven model, business platforms and operating strategies will continue to provide SJW customers with superior service levels, reliable water supplies, and reasonable rates ad SJW shareholders with a growing base of assets, a robust balance sheet and an excellent return on their investment.

That concludes my remarks for today. I'd like to open up the floor to your questions. Operator?

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Michael Gaugler of Brean Murray Carret. Please proceed.

Michael Gaugler – Brean Murray Carret

Hi, Rich.

Richard Roth

Good morning, Michael.

Michael Gaugler – Brean Murray Carret

How you doing today?

Richard Roth

Fine, thank you.

Michael Gaugler – Brean Murray Carret

Listen, a couple of questions. First, it sounds like you're feeling pretty good about water supplies going into the summer?

Richard Roth

I think as good as we can feel, and as we stated before, we're in constant communication with our wholesale water supply, the Santa Clara Valley Water District and they have indicated to us, we checked with them, in fact, this morning to reconfirm that they expect to be able to meet our demands for 2008 and deliver water per the contracts that we've with them.

Michael Gaugler – Brean Murray Carret

Okay. Any updates on the situation with pumping in the delta?

Richard Roth

Yes, there is an update. Judge Wanger who is the judge that's making these rulings about water pumping restrictions from the delta has indicated that there may be a need to protect some of the salmon runs in the fall and right now, the restrictions go from January to June, and there are no restrictions, at least now, planned for the summer, but there may be, it's not final yet, but he is talking about perhaps restrictions in the fall as the salmon migrate through the delta. So that's the latest word we have, but nothing quantitative or more definitive than that.

Michael Gaugler – Brean Murray Carret

Okay. I haven't heard you talk a whole lot about the California water action plan, just kind of bits and pieces here and there. Are you expecting to see any see any major impacts from that this year or next year?

Richard Roth

I think there are several companies, I think three, in fact, that have actually received their tiered conservation rates, and they will be implementing those. San Jose Water Company and some other IOWC's are in sort of the second phase of that proceeding and we don't expect right now, it's our best guess is that, certainly conservation rates for SJW will not be implemented until the end of the summer and maybe as late as first part of 2009. Some issues are still out there regarding potential ROE reductions for RAMs [ph] and so forth, but those will work their way through the system, I suppose over the course of 2008.

Michael Gaugler – Brean Murray Carret

Okay. And last question, always my favorite, any update on logging plans?

Richard Roth

I'm sure glad you asked that, Mike.

Michael Gaugler – Brean Murray Carret

I'll bet you are.

Richard Roth

Yes. No, we're still working closely. We've asked for some information from the Board of Forestry to better understand their decision and we are seeking an appeal with the board, so stay tuned, Michael. Nothing new yet, but we are going over information to better understand why they rejected our initial application for a logging permit in the Santa Cruz mountains.

Michael Gaugler – Brean Murray Carret

You have an appeal filed already. Is there like a hearing date for when that will be heard, or is this still exploratory?

Richard Roth

We've applied for an appeal hearing, but we're awaiting information from Cal Fire, it's California Forestry, the state government agency and we're waiting for information from them. So, that's going to dictate when the hearing actually takes place. We'd like to be well equipped with that information before we go to the appeal.

Michael Gaugler – Brean Murray Carret

Okay. Thanks, Rich.

Richard Roth

You're welcome. Thanks, Michael.

Operator

(Operator instructions) Your next question comes from the line of Heike Doerr of Janney Montgomery Scott. Please proceed.

Heike Doerr – Janney Montgomery Scott

Good morning Rich, Angela, how are you today?

Richard Roth

Fine, thank you.

Heike Doerr – Janney Montgomery Scott

I wanted to switch topics a little bit and focus on a business I'm a little less familiar with, which is the SJW Land. You have a REIT analyst and they talk about assist retail space, if somebody goes into default, how that impacts their leases and I wanted to touch briefly on that and how you see the economic indicators in the cities that you have most of your real estate and if there's any risk there to your businesses, particularly in Knoxville and maybe in Winsor, Connecticut.

Richard Roth

Okay, maybe just a little bit of background to provide a little better context for your question. Our approach and our philosophy I think has been cited before and is in our regulatory filings is, almost all of our properties are leased under triple net terms, meaning that the tenants are responsible for all upkeep, all maintenance, all taxes, and so forth meaning what we get in the form of rent would not be reduced by operating expenses. Furthermore, all of our tenants are what we would consider, and I think most real estate industry experts would consider, credit tenants. They are either large companies with strong balance sheets or publicly traded companies or subsidiaries of publicly traded companies who have excellent balance sheets and credit capacity.

We do have a lease in Knoxville that's very large. Our property in Knoxville that represents roughly half of our real estate portfolio that is leased to a very large private equity tenant and retailer, and so we watch those things carefully, but we've no reason to believe that the areas in which we've investments are experiencing at least on the commercial side, any significant credit problems, of course the residential side is a different thing but we're only in the commercial, industrial warehouse leasing.

Heike Doerr – Janney Montgomery Scott

Now, I believe it's not disclosed in the 10-K. Is there anywhere where we can see who it is that you're leasing to?

Richard Roth

No. We can't do that. We are –

Heike Doerr – Janney Montgomery Scott

So that won't be disclosed?

Richard Roth

No. It will not.

Heike Doerr – Janney Montgomery Scott

Okay. Thanks. That's all I have.

Richard Roth

Okay, thanks.

Operator

(Operator instructions) Your next question comes from the line of Michael Gaugler of Brean Murray Carret. Please proceed.

Michael Gaugler – Brean Murray Carret

Hi Rich. Just one follow-up question since nobody else asked. Acquisitions, what are you seeing out there right now?

Richard Roth

We're most active in pursuing acquisitions in Texas. We have some smaller things that I don't think are, small systems in San Jose that we acquire as part of a mostly a good neighbor policy to take care of very small systems. I don't think they're all that materially relevant. In Texas, we did close an acquisition in the first quarter that added several hundred customers. We see those as, again, pretty much part of our ongoing business there and the other things that we've pending in Texas have not been disclosed and I'm not able to discuss them other than in a general sense, Michael, in that it is a very, continues to be a very strong economic environment in Texas with continued job growth which is the requirement, the major requirement for strong housing growth and expansion. We also know that in Texas that they continue to expand their transportation corridors around the service areas that we've which I think bodes very well. They have several toll roads going in and they're widening some of the other highways between Austin and San Antonio, so I hope I'm able to report in the following quarters that our progress in that area has continued, but we're fairly positive about our prospects in Texas and continue to work on things in California as well.

Michael Gaugler – Brean Murray Carret

Thanks again, Rich.

Richard Roth

You're welcome.

Operator

Your next question comes from the line of Bill Garrison [ph] of Iron Mark Capital. Please proceed.

Bill Garrison – Iron Mark Capital

Yes, thank you. It seems like operating expenses were better than I had anticipated during the quarter. I wanted to see if you could provide any additional commentary with respect to any specific factors in the first quarter or in subsequent quarters as we look forward to your operating expenses and as well if you could comment on what your thoughts are about maintenance expense for 2008. Thank you.

Richard Roth

We did see some pretty important reductions, I don't know that they were very really large, but we did see a reduction in main breaks in the first quarter which, that's kind of hard to predict and a little bit of alchemy rather than science involved in when those occur. But the major things are just really trying to watch our Ps and Qs with respect to energy consumption and the raw material cost, whether they're for fuel or other vendors like that. They are a large part of cost of doing business and just other than that, pretty much sticking to our plan which is, a lot of it is embodied in our general rate case so that we can continue to track those costs that are allowed in the general rate case in our actual operations.

So we continue, I expect looking forward and I think that we're still probably going to see some rippling through of our cost structure of rising energy prices and it's going to be continually require management here to do a real good job in controlling those and probably be a combination of maybe changing some business policies and approaches, but I think it will continue to be a challenge going forward.

Bill Garrison – Iron Mark Capital

And are there any significant costs to your green initiatives in the next few quarters?

Richard Roth

No, there are some larger elements of that like the photovoltaic and other efforts we are doing to really reduce energy consumption in our water production operation, and those are growing and there's a lot more interest and a lot more cooperation between energy and water utilities in California and to allow that to happen, it's actually, CPUC plays an important role there. We're increasing as it makes sense, the fuel efficient vehicles in our fleet, but a lot of what we're doing here is just kind of common sensical things like making sure that a lot of, well any kind of consumption we have, recycling materials, turning off lights automatically, turning thermostats down and doing a lot of just common sense things that, believe it or not, really contribute when you do all of them, they contribute to a meaningful reduction in cost. So a lot of it's just being smart and as the technology involved in photovoltaic, solar and other forms of alternative energy come and are available for us, we're going to continue to explore them. So structurally, there isn't any real cost associated. We look at things like carbon credits in our watershed and things like that, but we haven't done anything in that regard, but I hope that gives you some flavor.

Bill Garrison – Iron Mark Capital

Yes, thank you.

Richard Roth

You're welcome.

Suzy Papazian

Operator, are there anymore questions?

Operator

It appears at this time there are no further questions.

Richard Roth

Thank you very much, everyone. Then I really appreciate the attention you've given us today. Please consider SJW Corp. as a premier defensive investment in the water industry. We've nice positive results going forward and in the past, from two growing regional water companies and a portfolio of investments operating on a strong business model focused on building the regulated asset base and cash flow. So thanks again for all your attention and I look forward to seeing you and talking to you next quarter.

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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