Mr. Sorenson: W.H. Reaves & Company was founded by Bill Reaves in 1961 as a research boutique to provide independent research with respect to the utilities industry. Previous to that, he was with Kidder, Peabody as an electric utility analyst. He set up the firm, bought a seat on the New York Stock Exchange and, until May Day 1975, basically the firm prospered because of the quality of its independent research. After May Day 1975 when commissions became negotiable, he had to rethink his business model, because the number of people who were going to be willing to pay for research would be less and less every year. In discussions with one of the companies that he had researched and knew well, Tampa Electric, they asked if he managed money, and he said, well no, but we manage our own Profit Sharing Trust. He showed them the performance of the Profit Sharing Trust — this is in 1977 — and he was immediately hired to manage a portion of their defined benefit pension plan. I am pleased to say that Tampa Electric was our first client and they're still a client after 31 years. The core of the business that we invest in and research has expanded somewhat from just the traditional electric utility and natural gas pipeline industry. With the breakup of AT&T (T) into the Regional Bells, we added the telephone companies to our investment universe. Obviously, some of the major inputs to the utility sector is energy by way of coal, natural gas, oil and, not so much in the last decade or so, uranium. As a result we invest and research the traditional energy sector as well. One area of regulated utilities, which has a lot of promise, is the water sector. Historically there have been limited opportunities to invest in the water utility sector, but there are currently US- domiciled water utilities with a market capitalization in excess of $2 billion listed on the New York Stock Exchange. What's unique about these companies is that they really are true monopolies. With regard to what we look for when we invest in companies in these industries, we look for companies that are profitable, have good balance sheets, have a history of paying dividends and, most important, are raising their dividends over time. We also look for reasonable valuation and reasonable valuation can be reflected in price to book, p/e ratio and obviously the level of the dividend yield. We don't pursue the highest dividend yield because we're really focused on the best total return that we can achieve for our investors, and the best total return doesn't necessarily come from companies that pay the highest dividends. It's a combination of both moderate and predictable earnings growth together with the dividend, which provides the investment opportunities. One dimension of our research that I haven't mentioned so far that's critical to success in the utility space relates to regulation. In the utility space, companies can be subject to regulation at the local, state and the federal level. You could classify that in general terms as an element of political risk. But if you don't do well in terms of following regulation, understanding it and incorporating that into your investment decision, you are not going to do as well as you should. In some cases you could suffer terrible investment disappointments. One aspect of the companies that we invest in is that, if you think about their products and services, they are largely non- discretionary. What that means is, even in periods such as now when we've had a real economic setback and there are a lot of concerns about economic growth, concerns about lack of transparency, lack of visibility on future earnings, all the companies in our portfolio are still making money. Obviously there has been some demand disruption from industrial slowdown with respect to electric consumption. That's also true for natural gas and oil. In the telecom space, there's been some cutback on capital formation and capital investment. But the fact of the matter is all these companies continue to make money and, as I mentioned earlier, it's very important that they pay dividends. We expect half to two-thirds of the companies in our portfolios to increase their dividends or have the potential for increasing their dividends over the next year or two.1 A number of them, AT&T in particular, have raised their dividends. When you think about the utility space, our disappointment is that the market doesn't really discriminate between the companies in the space. I could give you examples of companies that are all classified as gas companies, and as businesses they are very, very different companies, not only with respect to the kinds of services that they provide, but their geographic location, the regulatory risk that they face, their earnings growth rate and the potential for growing the dividend. If you want to step back for a second and look at our investment record, we've outperformed the S&P 5002 over the period that we've been managing money for others. There was an article published some time ago entitled "The Greatest Return Stories Ever Told." That was a study, conducted without our participation, by the Ford Foundation and we were ranked very highly against a lot of outstanding investors who had a great variety of investment strategies.3 That speaks to the fact that obviously we've been consistent with our investment process, but at the same time it also speaks to the value of the kinds of companies that we invest in.
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