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Avista Corporation (NYSE:AVA)

Q3 2008 Earnings Call Transcript

November 4, 2008, 10:30 am ET

Executives

Jason Lang – Manager, IR

Scott Morris – Chairman, President and CEO

Malyn Malquist – EVP

Mark Thies – SVP and CFO

Kelly Norwood – VP, Regulatory Affairs

Christy Burmeister-Smith – VP, Controller and Principal Accounting Officer

Analysts

Brian Russo – Ladenburg Thalmann

David Thickens – Deephaven Capital Management

Hasan Doza – Luminus Management

Oliver King – Zimmer Lucas

Patrick McGlinchey – Sidoti & Company

James Bellessa – D.A. Davidson & Company

Chris Ellinghaus – Shields and Company

Timothy [ph] – KeyBanc

Operator

Good day, ladies and gentlemen, and welcome to the third quarter 2008 Avista Corporation earnings conference call. My name is Heather 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 at the end of the conference. (Operator instructions) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today's call, Mr. Jason Lang, Manager, Investor Relations. Please proceed, sir.

Jason Lang

Thank you, Heather. Good morning, everyone. Welcome to Avista's Third Quarter 2008 Earnings Conference Call. Our earnings were released premarket this morning and the release is available on our Web site at avistacorp.com.

Joining me this morning are Avista Corp. Chairman of the Board, President and CEO Scott Morris; Executive Vice President, Malyn Malquist, Senior Vice President and CFO, Mark Thies; Vice President of Finance and Treasurer, Ann Wilson and Vice President, Controller and Principal Accounting Officer, Christy Burmeister-Smith.

Before we begin I would like to remind you that some of the statements that will be made today are forward-looking statements that involve risks and uncertainties which are subject to change. For reference to the various factors which could cause actual results to differ materially from those discussed in today's call I would direct you to our Form 10-K for 2007 and Form 10-Q for the quarter-ended June 30th 2008, which are available on our Web site.

To begin this presentation I would like to recap the financial results presented in today's press release. For the third quarter of 2008, our consolidated net income was $0.13 per diluted share, compared to a net loss of $0.07 per diluted share for the third quarter of 2007. On a year-to-date basis our earnings were $1.04 per diluted share compared to $0.45 per diluted share for the first nine months of 2007.

Now I'll turn the discussion over to Avista's Chairman of the Board, President and Chief Executive Officer, Scott Morris.

Scott Morris

Thank you, Jason, and good morning, everyone. Overall, we are pleased with our results for the third quarter and the first nine months of 2008. Our financial results for the first nine months of 2008 have positioned us to meet the earnings targets we set for this year.

We expect continued improvement in our financial results due to the implementation of a general rate increase in Idaho which was effective October 1st. The general rate increase in Washington implemented at the beginning of 2008 with the primary reason for the improvement in our utility performance.

In addition to the improvement at the utility, our consolidated results improved as compared to 2007 due to the net loss at Avista Energy in 2007.

Contributing to the improvement in utility results for the third quarter of 2008 as compared to the third quarter of last year was lower electric resource costs as compared to the amount included in base rates.

We had a benefit of $100,000 in the third quarter of 2008 as compared to an expense of $5.2 million for the third quarter of 2007 under the energy recovery mechanism in Washington. This was primarily due to improved hydroelectric generation and resetting the base level of power supply costs in the Washington general rate case.

On a year-to-date basis we have absorbed $7.3 million of costs under the ERM compared to $7.6 million in 2007. Despite a good winter snow path, the late spring run off resulted in excess water being spilled which yielded lower than normal hydroelectric generation for the first nine months of 2008.

Purchase power costs were higher than expected due in part to colder than normal temperatures during the heating season and an increase in the price of wholesale power. Although we had above normal hydro generation from mid-May through September it was not enough to make up the entire shortfall from earlier in the year. Actual hydroelectric generation for the year will depend on precipitation, temperatures and other variables during the fourth quarter.

It's important to note that the amounts recognized under the ERM can vary significantly from quarter-to-quarter due to a variety of factors including the level of hydroelectric generation as well as changes in purchase power and fuel costs.

However, we have limited downside earnings risk for the fourth quarter of 2008 as we are currently in the 90% customer, 10% company sharing band under the ERM due to power supply costs exceeding the amount included in base rate by over $10 million on a year-to-date basis.

Partially offsetting the negative effect of higher electric resource costs on a year-to-date basis was higher than expected retail natural gas flows due to colder than normal weather during the heating season earlier in the year.

Also contributing to the increase in income was $5.7 million of interest income related to income tax settlements for the company's 2001 through 2003 tax year which included the settlement of the indirect overhead cost issue. This was partially offset by $1.4 million of interest expense related to income tax settlement for the 2004 and 2005 tax years. Both amounts were recorded during the third quarter of 2008.

As approved by the Idaho Public Utilities Commission, electric rates for Idaho customers increased by 12% and natural gas rates increased by 4.7%, effective October 1. Combined these rate changes are designed to increase annual revenues by $27.1 million. We are pleased that all parties to the rate case worked together to achieve a reasonable resolution to the issue.

In September 2008 we entered into a settlement stipulation with parties with respect to our general rate case that was filed with the Washington Utilities and Transportation Commission in March of 2008. Other parties to the settlement stipulation are the staff of the WTC northwest industrial gas users and the energy project.

The recommendations of these parties to approve the settlement are not binding on the WTC. The industrial customers of northwest utilities joined in portions of the settlement. The public counsel section of the Washington Attorney General's Office did not join in the settlement stipulation. Evidentiary hearings before the WTC are scheduled for this Thursday, November 6, and Friday, November 7, 2008.

As agreed to in the settlement base electric rates for the company's Washington customers would increase by an average of 9.1% which is designed to increase annual revenues by $32.5 million. Base natural gas rates for the company's Washington customers would increase by an average of 2.4% which is designed to increase annual revenues by $4.8 million. If approved by the WTC the new electric and natural gas rates would become effective on January 1st of 2009 and we expect to receive an order from the WTC in December.

The settlement is based on an overall rate of return of 8.22% with common equity ratio of 46.3% and a 10.2% return on equity. The settlement stipulation would also provide for modification of the ERM for the annual power supply cost variances in the 4 million to 10 million bands.

The adjustment would result in a 75% customer, 25% company sharing when actual power supply expenses are lower than the amount included in base retail rates within this band. This results in customers receiving 75% of the benefit and the company receiving 25%.

Currently, costs are shared evenly within this band. The 50% customer, 50% company sharing would be maintained when actual power supply expenses are higher than the amount included in base retail rates within this band.

As we continue to invest in the growth and upgrade of our company generation, transmission and distribution infrastructure, we will continue to timely filing of general rate cases to recover our costs of doing business and to more closely align our rates of return with those allowed by regulators.

At the same time, we are diligently managing our operating costs and finding additional efficiencies to help reduce costs. We are planning to file general rate cases in each of our jurisdictions before the end of the first quarter of 2009.

I would like to comment about the economy and our service territory. Over the last several years our regional economy taken as a whole grown faster than the nation when measured by job and population growth. Although our service territory appears to be fairing better than certain other parts of the country, we are not immune from the turbulence affecting the national and international economy and financial markets.

We are observing stable to small declines in employment throughout our service area due to cut backs in construction and financial services sectors. However, agriculture, mining, healthcare and manufacturing sectors, our primary industries, continue to perform well, while lumber markets continue to struggle.

Unemployment rates, though higher than a year ago, are below the national average in eastern Washington and northern Idaho, but above in southern Oregon. This has led to a relatively balanced housing market with stable prices keeping foreclosures in check. Through the rest of 2008 and throughout 2009 we expect our service area economy to exhibit slow growth in employment and population when compared to past trends.

We are very pleased that Mark Thies joined Avista at the end of September as our new CFO. Mark has a solid background in finance and the utility industry. And his leadership style is complementary to our culture. We've really enjoyed working with Mark during the past five weeks and it's been a seamless transition in the CFO transition.

As we previously stated Malyn has expressed his desire to retire at some point in the near future. Malyn remains an invaluable member of our senior leadership team. He is now focusing his expertise on guiding subsidiary strategic planning, on assuring that the CFO transition continues to go smoothly and sharing his insightful 30-plus years of utility experience with all of us.

And now I'll turn this presentation over to Malyn Malquist for a review of our capital budget and our progress with advantage IQ.

Malyn Malquist

Thanks, Scott, and good morning everyone. For the first nine months of 2008, our capital expenditures were approximately $150 million. For the full year of 2008 our capital budget is approximately $200 million and we are expecting our capital budgets to exceed $200 million in 2009 and 2010. We expect our rate base to grow by about 5% to 7% per year in 2009, 2010 and 2011. We are planning to upgrade certain hydro projects and we will continue to enhance our natural gas and electric distribution systems.

In the second quarter of 2008 we completed the acquisition of a wind generation site. We expect to construct a 50-megawatt generation facility at an estimated cost of over $125 million with the majority of the costs expected to be incurred between 2011 and 2013. This schedule has been moved out from what we discussed on our previous call.

Through our planned hydro upgrades and other available renewable resources we can and will meet our near-term renewable portfolio standards, and do so in a less costly fashion than moving forward in 2009 with the wind project. We remain committed to the project but we believe that the current economic environment warrants pushing the project out a year or two.

In June 2008 we filed petitions with the Washington and Idaho Commissions requesting that costs including land, turbine down payments and other preliminary costs associated with the wind projects be accounted for as construction work in progress. This would allow for accrual of AFUDC. In July 2008 the Idaho Commission approved our request and the matter is still pending in Washington.

We are participating in project development and planning activities for the development of a proposed 3,000 megawatt transmission project that would extend from British Columbia, Canada to northern California. Other participants include Pacific Gas and Electric Company, Pacific Core, and British Columbia Transmission Corporation.

We've executed an agreement with the other participants in order to perform preliminary studies and assessments for the project including electrical system studies and resource mapping of possible transmission line corridors. Under the agreement we have committed to contribute $400,000 or 12% of the total preliminary costs of the project.

Advantage IQs net income for the third quarter and first nine months of 2008 were lower than the comparable periods of 2007. This was primarily due to the decrease in our ownership percentage in the business with the acquisition of Cadence Network effective July 2, 2008, and due to an increase in amortization of intangible assets related to the Cadence acquisition.

On a year-to-date basis total revenues increased 21% with service revenues increasing 33% partially offset by a 30% decrease in interest revenue. During the third quarter of 2008 Advantage IQ signed over 25,000 new accounts. These new accounts are estimated to result in annual revenues of approximately $1.4 million. This was a significant increase in new account signings as Q1 and Q2 combined for 2008 was just over 11,000 new accounts.

As consideration for the merger the previous owners of Cadence Network received a 25% interest in Advantage IQ. While we anticipate an increase in annual revenues as a result of the acquisition the transaction is expected to be slightly dilutive to our consolidated earnings in 2008 by $0.01 to $0.02 per share due to the decrease in our ownership of the subsidiary and the amortization of intangible assets resulting from the transaction. However, as Mark will discuss later, we continue to expect to meet the earnings guidance we have given for this segment in 2008.

We are planning to monetize at least a portion of our investment in Advantage IQ during the next two years to four years. The potential monetization could be completed through an initial public offering or a sale of the business depending on future market conditions, growth of the business and other factors.

Under the transaction agreement the previous owners of Cadence Network can exercise a right to reviewing their shares of Advantage IQ stock during July 2011 or July 2012 if Advantage IQ is not monetized through either an initial public offering or sale of the business to a third party. The redemption rights expire on July 31st 2012. The redemption price would be determined based on the fair market value of Advantage IQ at the time of the redemption election as determined by certain independent parties.

To prepare for a monetization event we have revamped the board of this subsidiary. Previously, the board was made up of one of Avista's Corp.'s outside board members, Kristi Blake, the Advantage IQ Chief Executive Officer, Stu Stiles, Avista Corp.'s General Counsel, Marian Durkin, Scott Morris, our CEO and me.

As part of our merger with Cadence we have reconstituted the board with an external focus. Kristi Blake of Avista Corp.'s Audit Committee Chair remains on the board as does Scott Morris and Stu Stiles.

In addition we've added Jeff Lieberman of Insight Partners, a venture capital fund based in New York City. This fund was the majority owner of Cadence. We've also asked John Kelly, Avista Corp. lead director and former Chief Executive Officer of Alaska Airlines to serve on the Advantage board as well as Eric Anderson, Avista Corp. board member and President of West River Capital, a Seattle-based venture capital firm.

We believe that the collective expertise and experience of this group will help us take Advantage IQ to the next level and help us prepare for an IPO or other monetization events. The consolidation of the two companies has gone very smoothly and we believe that our team is clicking on all cylinders. We are very excited and optimistic about the future of this business.

In our other businesses on a year-to-date basis our results improved over 2007 primarily because of the net loss from Avista Energy in the prior year. The remaining activities of Avista Energy are no longer a reportable business segment and are included in other for segment reporting purposes.

Overtime as opportunities arise we plan to dispose of assets and phase out operations that do not fit with our overall corporate strategy. However, we may invest incremental funds to protect our existing investments and invest in new businesses that fit with our overall corporate strategy.

Now I'd like to introduces our new CFO, Mark Thies. Mark is an accomplished leader with extensive experience in finance, risk management, accounting and administration in the utility sector primarily in the Midwest. Prior to joining Avista he was Executive Vice President and Chief Financial Officer for Black Hills Corporation, a diversified energy company providing regulated electric and natural gas service to areas of South Dakota, Wyoming and Montana. Mark will provide further details on the performance of Avista utilities, liquidity, our financing activities and our earnings guidance.

Mark Thies

Thanks, Malyn, and good morning everyone. I'm happy to be joining my first call with Avista Corporation and I'm very excited about going forward. Avista's Utilities contributed $0.12 cents per diluted share for the third quarter of 2008, compared to a net loss of $0.10 per diluted share for the third quarter of last year. On a year-to-date basis our utility operations contributed $0.96 per diluted share, an increase from $0.59 per diluted share in 2007.

As Scott mentioned the improvement in results was primarily due to the Washington general rate case implementation as well as the third quarter benefit under the ERM as compared to a significant amount of cost absorbed in the third quarter of 2007 as well as interest income from income tax settlements.

Also during the third quarter of 2007, we recorded a pretax impairment charge of $2.3 million related to a turbine in $3.8 million of unamortized debt repurchase costs were disallowed as part of our Washington general rate case settlement.

For both the third quarter and year-to-date 2008 interest expense decreased as compared to the prior year. This was primarily due to the redemption of all outstanding preferred stock in September 2007 and the effect of the long-term debt maturities during 2007 and 2008, which were primarily funded with proceeds from the sale and liquidation of Avista Energy's assets and debt issuances at lower interest rates.

During the nine months ended September 30, 2008, debt maturities were $295 million, the majority being the $273 million of 9.75% unsecured senior notes that matured on June 1st. In April, we issued $250 million of 5.95% first mortgage bonds to fund a significant portion of this debt that matured.

The recent events in the financial markets have resulted in companies having limited access to capital on reasonable terms and have resulted in a significant increase in borrowing rates for corporations.

We are exploring various alternatives that will enable us to continue to obtain funding at a reasonable cost. As of November 3, 2008, we had received commitments from three banks totally to $130 million for a new 364 day bank credit facility at a reasonable cost. The company is continuing to seek additional commitments from other banks. Closing, subject to completion of the necessary documentation is expected by the end of November 2008.

We are committed to maintain an adequate liquidity and will continue to utilize cash flow from operations, long-term debt and common stock issuances to fund our capital expenditures and maturing debt and use short-term debt for these purposes on an interim basis.

As of September 30th 2008, we had $203 million of available liquidity under our $320 million committed line of credit and $85 million revolving accounts receivable sales facilities.

We have a sales agency agreement to issue up to 2 million shares of our common stock from time to time. We issued 750,000 shares of common stock under this agreement during the third quarter of 2008 and received net proceeds of $16.6 million. We will continue to evaluate issuing common stock and may issue common stock under this agreement in future periods.

Due to recent market conditions and the decline in the fair value of pension plan assets our contributions to the pension plan in 2009 could increase significantly as compared to $28 million we contributed in 2008.

The final determination of pension plan contributions for 2009 and future periods is subject to multiple variables most of which are beyond our control including further changes to the fair value of pension plan assets and changes in actuarial assumptions, in particular, the discount rate used in determining the projected benefit obligation. We believe that we have adequate liquidity to meet our pension plan funding obligations for 2009.

As we've indicated in past calls management intends to recommend to the board to consider gradually increase dividend pay out ratio to become more in line with the average pay out ratio for the utility industry which is currently approximately 60% to 70% of earnings.

The board raised the quarterly dividend by 9% from $16.015 to $0.18 per share in August. Management intends to recommend that the board further review our dividend level during 2009. The board considers the level of dividends on a regular basis taking into account numerous factors including financial results, business strategies, economic and competitive conditions. The declaration of dividends is within the sole discretion of the board.

At this time I'd like to talk about guidance. We are narrowing our guidance for 2008 consolidated earnings to a range of $1.35 per diluted share to $1.45 per diluted share, primarily as a result of costs absorbed under the ERM. Our guidance for this utilities is being narrowed to a range of $1.20 per diluted share to $1.35 per diluted share in 2008. Our outlook for Avista Utilities assumes among other variables normal precipitation, temperature, hydroelectric generation for the fourth quarter.

As Malyn mentioned our guidance for Advantage IQ continues to be in the range of $0.10 to $0.12 cents per diluted share. We expect other businesses to be between a loss of $0.02 and break even per diluted share. We are also initiating our 2009 guidance for consolidated earnings to be in the range of $1.40 per diluted share to $1.60 per diluted share.

We expect Avista Utilities to contribute in the range of $1.30 per diluted share to $1.45 per diluted share for 2009. Our outlook for Avista Utilities assumes among other variables, normal precipitation, temperatures and hydroelectric generation. Our outlook also assumes the approval and implementation of the Washington general rate case on January 1, 2009, as designed in the September 2008 settlement agreement with certain parties.

Additionally, our outlook reflects estimated 2009 pension plan expense based upon estimated pension valuations as of September 30th 2008. The actual pension plan expense for 2009 is subject to multiple variables most of which are beyond our control including further changes to the fair value of pension plan assets and the discount rate.

We expect Advantage IQ to contribute in the range of $0.12 to $0.14 per diluted share and other businesses to be between a loss of $0.02 and a contribution of $0.01 per diluted share.

Although the recent settlement agreement in Idaho and the pending multiparty agreement in Washington provide incremental progress in recovery of utility costs, the company will still experience regulatory lag in 2009 especially related to the recent higher escalation in operation and maintenance costs and utility capital investment in 2009 which will not be included in 2009 retail rates.

Avista plans to file new general rate cases in all three states prior to the end of the first quarter of 2009 to more closely align earned returns with those authorized by regulators. I'll now turn it over to Jason.

Jason Lang

Thanks, Mark. Now we like to open this call up for questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator instructions) Your first question comes from the line of Brian Russo with Ladenburg Thalmann. Please proceed.

Brian Russo – Ladenburg Thalmann

Hi, good morning.

Scott Morris

Good morning, Brian.

Brian Russo – Ladenburg Thalmann

It seems that the settlement in Washington would lead to a significant step up in utility earnings in 2009, but yet still only assuming it looks like a $0.10 pick up in the bottom and top of the range. I know you mentioned that you've included incremental pension expense. Can you quantify that some more, please?

Scott Morris

Mark, why don't you go ahead and take that?

Mark

Okay. We have included this. The pension item is really looking at where we are as of September 30th. So we've included amounts up to that level. We haven't disclosed specific amounts in the pension. It also results from just overall increase in operating costs which we continue to try to manage and diligently manage, but costs have continued to increase and we have some lag as we mentioned we expect to file some additional rate cases. So there is a combination of things. We did just settle or we do assume a settlement, but we have additional costs and our capital as Malyn mentioned, we expect to have 5% to 7% increases in our rate base that will have experienced some lag as well.

Brian Russo – Ladenburg Thalmann

What's your assumed allowed ROE in the '09 guidance?

Kelly Norwood

The allowed return is 10.2% ROE.

Scott Morris

That was Kelly Norwood our VP of Regulatory Affairs.

Brian Russo – Ladenburg Thalmann

Okay. And then what's the fully diluted shares outstanding we should assume for '09?

Malyn Malquist

We are getting that, Brian. Brian, this is Malyn. I guess the other comment I would make as Mark alluded to at the end of his comments, the regulatory lag really – it probably means that we are looking at as much as a couple hundred basis points difference between what is allowed in rates and what we are going to earn in 2009 and that's one of the reasons that Kelly and his team are preparing to file additional rate cases in 2009.

Brian Russo – Ladenburg Thalmann

Right. That regulatory lag, are there any initiatives in place to kind of narrow that lag? Or is it just a function of continuously filing rate cases?

Scott Morris

Brian, Kelly has made some good progress in that area. He still has some work to do. I am going to let have Kelly kind of overview a couple of the things that he has been able to accomplish.

Kelly Norwood

Yes, let me give you a couple of examples. One is the capital spending. As you know our capital budget is about $200 million and expect that to continue through the future. In the past the regulators in the northwest have not reflected the future capital expenditures in rate making. At this round both in Idaho and in the settlement agreement in Washington pending we were able to reflect the capital investment through the end of 2008 which is different than what they've done in the past. The next case will need to try to make further progress to reflect the future capital investment which will be in place during the time that rates are in effect. There has been some progress, but there's more progress which needs to be made. Also with O&M we experienced pretty significant increases in the last year or two and we are hopeful that will level off and we will be able to better reflect that in rate making this next round.

Scott Morris

I would say the O&M increases are primarily reflected in maintenance of some of our large thermal generation plants. As you know we are part owners of coal strip and as a partial owner as I would state it as routine maintenance and comes about we have to pay our fair share. So sometimes that peaks at certain times and those increases are tough to budget on a forward basis and get those in rates before you've actually performed the maintenance so does create lag.

Malyn Malquist

Brian, this is Malyn. Regarding the shares for next year. I would expect that – what's included in our guidance is around 2 million shares being issued and what we are doing there is basically trying to maintain our equity ratio at roughly the same level or growing a little bit from versus what we had in 2008 consistent with what we've planned to do with our regulatory filings to keep our equity ratio and roughly that 46% to 48% range.

Brian Russo – Ladenburg Thalmann

Alright. So about 55.2 million. Is accurate?

Scott Morris

It will be a little bit higher than that because of what we've issued this year.

Brian Russo – Ladenburg Thalmann

Okay. And just lastly you had a lot of success it seemed in the third quarter of signing up new accounts at IQ. And I was just wondering maybe if you could elaborate on that a little bit? And has the economic weakness at all impacted that business model?

Scott Morris

I think there is – I think that first the Cadence acquisition was a real plus for us and so we did have a very strong third quarter which was really a result of both entities having a lot in their pipeline and we continue to have a lot of sales activities looking at the fourth quarter and the first quarter of next year, there was a lot in the pipeline and we feel very good about that. Now the other plus is that as we've put these two companies together we are finding that there are additional service offerings that can be offered to existing customers that things that Advantage IQ does that Cadence didn't do and things that Cadence did that, Advantage IQ doesn't do like offering telecom payment processing to the Cadence customers, for example. Cadence has really had some outstanding consulting services that they offer that are really incremental to things that Advantage IQ does.

So we would expect those things to all be very positive looking at fourth quarter and really all of 2009. The downside is some of our customers are experiencing exactly what's going on in the economy. And so we have a number of retail customers who are closing stores. And so there is a little bit of a negative offset there as well as the fact that lower interest rates are a negative for us because we earn less on the float that we earn on customer funds. So there are plusses and minuses. But we expect to see continued fairly significant growth in revenues for next year for Advantage IQ. And that really translates to that roughly $0.02 earnings growth year-over-year that we put in guidance.

Brian Russo – Ladenburg Thalmann

Okay. Thanks a lot.

Operator

Your next question comes from the line of David Thickens with Deephaven Capital Management. Please proceed.

David Thickens – Deephaven Capital Management

Good morning.

Scott Morris

Hi, David.

David Thickens – Deephaven Capital Management

Hey, I just wanted to maybe get a little color on your expectations as you file a new rate case, particularly, in Washington here. The rub you've always had has been the issue of regulatory lag and historically, that's a problem that just hasn't gone away. Is there anything about this filing that you would get encouragement from that we can maybe do something to reduce the lag we've historically seen?

Kelly Norwood

David, this is Kelly. In both states as I mentioned earlier, both commission staff have better recognized the lag on capital and this hasn't been an issue in past years partly because our capital budget was closer to the amount of depreciation that we had. So the lag on capital was less of an issue as you look back 5 years or 10 years or 15 years. And I think it's the parties are now getting a better understanding that the way, the cost of materials have gone up and where the capital budget is situated now that there is a need to take a closer look at the dollars that are being spent that are serving customers that are not reflected in rate. As I mentioned we made some good progress this last round in reflecting year-end rate base for '08 which the parties had not picked up in prior years. And so I think there is an opportunity to the future in these next cases to reflect that future period capital and there is a reasonable opportunity I think to reflect that in rates which would help eliminate some of this lag.

David Thickens – Deephaven Capital Management

Can you talk about just some of the mechanisms you think you can employ?

Kelly Norwood

Well, through the – both states really would prefer to use a few mechanisms as possible outside of a general rate case. We have some very good mechanisms to track commodity costs. But in terms of dealing with this kind of lag, as long as we file rate cases each year which we are planning to do and actually that would be the staff and the parties preference, and as long as we reflect in those cases that future period capital, then you can do it inside of a general rate case.

David Thickens – Deephaven Capital Management

Okay. Thank you.

Kelly Norwood

Welcome.

Operator

Your next question comes from the line of Hasan Doza Luminus Management. Please proceed.

Hasan Doza – Luminus Management

Good morning, guys. I have a couple of questions on the pension. Would you guys be able to share as to what's the pension expense currently built into your rates, like '08?

Scott Morris

Mark, did you want to take that or did you want to –

Mark Thies

Probably Christy.

Scott Morris

Christy?

Kelly Norwood

This is Kelly. I will take a shot at that. I think that we did not make an adjustment to what was reflected in 2007 period. So whatever expenses we recognize in 2007 would be reflected in the rate.

Hasan Doza – Luminus Management

Do you guys happen to have that number handy? Like what – just ballpark what was the expense in '07?

Scott Morris

The expense, of the expense that we are booking is around $12 million per year, and I think that that's mostly reflected in rates at this point in time. So – but if we see a significant bump in 2009 which I think we will see some bump in expense that will not be reflected in rates until we go through another rate cycle.

Hasan Doza – Luminus Management

As you guys went through this current rate case you still maintain the $12 million level contribution?

Scott Morris

Roughly.

Kelly Norwood

That's right. And remember some of the pension costs is capitalized and some is expensed. So there is a breakdown there.

Hasan Doza – Luminus Management

Got you. And so the contribution that you will make in '09 will be a cash contribution and at this point you guys are not sure as to what will be the incremental cash contribution in '09?

Scott Morris

That is correct.

Hasan Doza – Luminus Management

Okay. That was my – and when do you guys think you will be able to share that information?

Scott Morris

We really have to – the calculation of that is based upon what our year end pension value is as well as what is the actuarial assumptions around discount rates. And so we really won't have that until the first couple of weeks in January and so I think we could talk about that on the next call that we have.

Hasan Doza – Luminus Management

I joined the call little late. Would you guys mind repeating your capital needs for '09 in terms of debt and equity or any maturities?

Scott Morris

Well, the capital budget for 2009 is roughly $200 million. And I guess I should let our CFO respond to that question. Sorry.

Mark Thies

As Malyn mentioned in our capital we expect the capital to exceed $200 million in 2009 and we do try to maintain the capitalization that we have in our allowed capitalization rate cases so 46% to 48% equity and the remaining debt. We also fund our capital budget not only with just debt and equity but also the internally generated cash flow we generate as a business on an ongoing basis. So but our capitalization would be consistent with what we have allowed in our regulatory rates of return, again 46% to 48% equity is the range and then the remainder with debt.

Hasan Doza – Luminus Management

Okay. One last question on your rate cases. Can you refresh us about the modified sharing mechanism that you guys instituted based on the debt band on this rate case and whether or not this would again be modified as you guys file the '09 rate cases?

Kelly Norwood

This is Kelly. The mechanism is scheduled to be revisited beginning in 2011. And as we work through this settlement agreement there is an argument there is some asymmetry in the variation of power cost as you look at the historical record of 50 years to 70 years meaning that the good years have a different level of variation than the bad years. There is an argument there is some asymmetry. Due to the settlement agreement we chose to go ahead and put in some asymmetry so that once you go through, in other words, if power costs are below what's built into rates we would keep the first $4 million but once you went beyond $4 million in the ERM, there would be 75% going to customers and 25% to shareholders in that range of $4 million to $10 million. Once you get beyond $10 million you still have the 90-10 sharing. On the – in the case where power supply costs are higher than normal then you still would absorb the first $4 million, there would be a 50-50 sharing on the next $4 million range to $10 million range, and 90-10 after that. Does that answer the question?

Hasan Doza – Luminus Management

Okay. And because I thought basically that there was some kind of a 75-25 sharing mechanism if the actual power costs were higher.

Kelly Norwood

No. If the power costs are lower than normal there's a 75-25 split, 75% going to customers, 25% to shareholders. Got it, okay? $4 million to $10 million range.

Hasan Doza – Luminus Management

Got it. Okay. That helps. Thank you very much.

Kelly Norwood

Welcome.

Operator

Your next question comes from the line of Oliver King with Zimmer Lucas. Please proceed.

Oliver King – Zimmer Lucas

Hi, Can you guys just elaborate a little more on your share issuance authorization program? How much has been issued this year, how much is left and how much you guys are issuing next year? And if it needs to be upsized at all in order to issue the amount of shares that you guys want to issue?

Scott Morris

Mark, do you want to take that.

Mark Thies

Sure, we've issued 750,000 shares of the 2 million shares for 2008. We continue to watch the market and will determine based on market conditions if we will issue more in 2008 or up to 2 million shares in 2009. Again, based on where the market conditions are.

Oliver King – Zimmer Lucas

Are you authorized to issue 2 million shares per year or is it just like a one-time program?

Malyn Malquist

We have – this is Malyn. We have 2 million shares that basically we have all the regulatory approvals to issue. If we go beyond the 1.25 million that's left under that we would have to file with our regulators for additional approval to issue the additional stock. Having said that our plan contemplates and the guidance that we've given contemplates doing more than the 1.25 million shares that's left under the registration.

Oliver King – Zimmer Lucas

Okay. Thank you.

Operator

Your next question comes from the line of Patrick McGlinchey with Sidoti & Company. Please proceed.

Patrick McGlinchey – Sidoti & Company

Good morning everyone. I just got a couple of questions on Advantage IQ here. If could you first just remind me the growth rate of Cadence over the past few years?

Scott Morris

The growth rate last year was over 30%. It was growing at about, even a little faster than Advantage IQ. I don't recall what it was in 2007 versus 2006, but they really have been on a similar trajectory to the kind of growth that we've experienced at IQ.

Patrick McGlinchey – Sidoti & Company

And looking out as you are thinking of monetizing a portion of that business, is there a metric that we could look at or a goal of other revenue or earnings that we can look towards rather than just maybe the two or three year time frame that you give?

Scott Morris

Yes. We really believe we need to see revenue for the company at $100 million or more and at that level we should be able to, in the right market conditions, obviously, execute an IPO. So we believe that we can get there in the next two years to three years.

Patrick McGlinchey – Sidoti & Company

Okay. And finally just, has there been a change in the level of the average daily balance that you're carrying there, for the funds of the customers?

Scott Morris

Yes, there have. That average daily balance has increased fairly significantly. It's – I haven't seen the latest statistics, but it's moved up and helped offset some of the lower interest expense that we've seen there.

Patrick McGlinchey – Sidoti & Company

Okay. Great. Thanks, guys.

Scott Morris

You're welcome.

Operator

Your next question comes from the line of James Bellessa with D.A. Davidson & Company. Please proceed.

James Bellessa – D.A. Davidson & Company

Good morning.

Scott Morris

Hi, Jim

James Bellessa – D.A. Davidson & Company

The income tax settlement – can you put that on an after-tax basis and what that might be per share that occurred in the third quarter?

Scott Morris

I think Kristi will answer that for you.

Christy Burmeister-Smith

(inaudible) pretax.

James Bellessa – D.A. Davidson & Company

I'm sorry, you broke up and I couldn't hear you.

Christy Burmeister-Smith

Sorry about that. Is better?

James Bellessa – D.A. Davidson & Company

Yes.

Christy Burmeister-Smith

Okay. We had interest income of $5.7 million. We had interest expense of $1.4 million, a net of $4.3 million which is about $0.05 per share.

James Bellessa – D.A. Davidson & Company Five cents a share did you say.

Christy Burmeister-Smith

Yes.

James Bellessa – D.A. Davidson & Company

And do you expect any tax settlements or potential once in the fourth quarter?

Christy Burmeister-Smith

No, we have finalized the audit of our 2004 year, 2005 year. They are now just starting on 2006, 2007.

James Bellessa – D.A. Davidson & Company

And you talked about in the narrative of this bank commitments of three banks totaling $130 million. Didn't you have a credit facility before? Why would you have to be trying to do something here in this contagent [ph], period of contagent?

Scott Morris

(inaudible)

Mark Thies

Jim, this is – we had an expectation and previously we've indicated that we would look to issue some additional first mortgage bonds. We issued some first mortgage bonds earlier this year and had indicated we would issue up to $100 million of first mortgage bonds in the fourth quarter. And the market as we've seen has been somewhat challenging conditions to get even investment grade transactions done in the bond market. So we were looking to maintain the liquidity as we go into next year and we had the bank group, very strong banks, the three banks include Union Bank of California, Wells Fargo and JP Morgan, committed a facility to get us beyond some of this uncertainty in the capital markets. We also have the coal strip bonds that will be due or remarketed by the end of this year and we may depending on market conditions may not be able to market those. We may have to repurchase those and then remarket those next year and this facility allows us to do that while maintaining our liquidity.

James Bellessa – D.A. Davidson & Company

And did I hear that you signed up, was it 25,000 new accounts at Advantage IQ.

Malyn Malquist

In the third quarter, Jim. This is Malyn. That's correct.

James Bellessa – D.A. Davidson & Company

And how many for – from IQ and how many were from the traditional Advantage?

Malyn Malquist

We actually don't have that split. Because we are running the business as one now so I really don't know that we have that break down.

James Bellessa – D.A. Davidson & Company

And they only be valued $1.4 million of revenues.

Malyn Malquist

That is what those customers will generate on an annual basis.

James Bellessa – D.A. Davidson & Company

That doesn't sound like a lot of money versus 25,000 accounts. So are these smaller entities, smaller shops or something like that?

Malyn Malquist

No, there are two or three fairly significant customers there. But I believe that most of them are just for the electric and gas utility kinds of bill payment processing. So – as customers come into the fold and start to deal with us we hope to be able to sell additional services to them. But that's all that they've signed up for at this point.

James Bellessa – D.A. Davidson & Company

Can you put the 25,000 in perspective with the total number of accounts you have?

Malyn Malquist

I don't know that I have the total number of accounts. We are looking for it.

Scott Morris

I think we are over 600,000 accounts. I think we will sign anywhere from roughly 60,000 new customers, new accounts per year, 65,000, which is a normal year.

James Bellessa – D.A. Davidson & Company

Thank you very much.

Scott Morris

Thanks.

Operator

Your next question comes from the line of Chris Ellinghaus with Shields and Co. Please proceed.

Chris Ellinghaus – Shields and Company

Hi, everybody, how are you?

Scott Morris

Hi, Chris.

Chris Ellinghaus – Shields and Company

Welcome aboard, Mark.

Mark Thies

Thank you.

Chris Ellinghaus – Shields and Company

Did you end up finding the diluted shares for guidance? I might have missed that.

Scott Morris

It's around 55 million, Chris.

Chris Ellinghaus – Shields and Company

Okay. And can I assume that there's still no assumption in guidance for any kind of ERM for next year?

Scott Morris

Mark?

Mark Thies

Correct. That would be correct.

Chris Ellinghaus – Shields and Company

Okay. And will we be getting the wind into the CapEx budget that you'll show us pretty soon?

Scott Morris

I think what you'll see with the wind is that in 2009 we don't have plans to spend much with capital budgets because we've got some other plans to invest in our hydro. There are some other opportunities in the market. So will you see that CapEx really start in the wind project around 2011.

Chris Ellinghaus – Shields and Company

I was more reflecting on sort of your CapEx budget that we are going to see come out.

Scott Morris

There is very little wind in the 2009 CapEx budget.

Chris Ellinghaus – Shields and Company

Okay. Alright. Thanks a lot. We will see you next week.

Mark Thies

Thanks, Chris.

Operator

Your next question comes from the line of Timothy [ph] with KeyBanc. Please proceed.

Timothy – KeyBanc

I had a question, it looks like you've eaten about a dime of ERM this year. If I add that back, just kind of – I'm late to the call so I'm sorry if I missed this. What's really pressuring '09? Is it pension and what's your forecast pension in that number or is it lag?

Scott Morris

Mark?

Mark Thies

I think it's more – we haven't really had a significant change in this year in the pension. It's more of the lag in the ERM and the consolidation for the utilities. The pension isn't – it's more of a lag on the overall increase in costs as well as where we are in the ERM. We are in the 90-10 right now to the negative.

Timothy – KeyBanc

I was asking more about '09 where you've assumed no ERM?

Mark Thies

In '09 that's truly more the lag on the operating costs, an increase in operating costs and as Scott mentioned earlier, there are a few of the power plants that we have that have coal strip being the one named that have higher maintenance budgets scheduled for '09 that aren't included in our rates yet. They haven't occurred.

Timothy – KeyBanc

What's your '09 versus '08 anticipation of higher pension costs?

Mark Thies

We haven't come out with the specific number as we – as Malyn mentioned earlier. Based on September 30 numbers we don't see a significant change from the expected in '08. But we do that calculation in the discount rate as a key factor that, we do that at the end of the year so we will know that in the first quarter. At this point we have not had a significant change in pension cost forecasted for next year based on 9/30.

Timothy – KeyBanc

The higher pension costs should eventually work their way in the rates when you file your next case, is that correct?

Scott Morris

That's correct.

Timothy – KeyBanc

I'm sorry if I missed this, but your 2 million shelf, how much is left?

Scott Morris

Mark?

Mark Thies

1.25 million.

Timothy – KeyBanc

That gets to your 55 average shares out in '09?

Mark Thies

Well, we would look – as Malyn said we would look to continue that program. We have certain approvals we need to get in anticipation of that, but we would expect some additional, that's part of it and we would expect some additional shares seek approval to go with some additional shares to maintain our capital ratios.

Timothy – KeyBanc

Okay. Thank you very much.

Operator

There are no further questions in the queue at this time. I would like to turn the call back over to Jason Lang for closing remarks.

Jason Lang

Thank you everyone for joining us today. We certainly appreciate your interest in Avista. Have a great day.

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: Avista Corporation Q3 2008 Earnings Call Transcript
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