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Executives

Jason Lang - IR Manager

Scott Morris - Chairman, President & CEO

Mark Thies - SVP & CFO

Dennis Vermillion - Sr. VP, Avista Corp & President, Avista Utilities

Analysts

Brian Russo - Ladenburg Thalmann

Jennifer Sireklove - McAdams Wright Ragen

Jim Bellessa - D.A. Davidson

Avista Corp. (AVA) Q2 2010 Earnings Call Transcript August 5, 2010 10:30 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the second quarter 2010 Avista Corporation earnings conference call. My name is Novella and I will 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 this 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, Investor Relations Manager. Please proceed.

Jason Lang

Thank you, Novella. Good morning everyone. Welcome to Avista’s second quarter 2010 earnings conference call. Our earnings were released pre-market this morning and the release is available on our website at avistacorp.com.

Joining me this morning are Avista Corp. Chairman of the Board, President and CEO, Scott Morris; Senior Vice President and CFO, Mark Thies; Senior Vice President and the President of Avista Utilities, Dennis Vermillion; Vice President of Finance Jason Thackston; and the Vice President and Controller and Principal Accounting Officer, Christy Burmeister-Smith.

Some of the statements that will be made today are forward-looking statements that involve risks and uncertainties, which are subject to change. For a reference to the various factors, which could cause actual results to differ materially from those discussed in today’s call, please refer to our Form 10-K for 2009 and Form 10-Q for the first quarter of 2010 which are available on our website.

To begin this presentation, I’d like to recap the financial results presented in today’s press release. For the second quarter of 2010, our consolidated earnings were $0.46 per diluted share compared to $0.47 per diluted share for the second quarter of 2009. On a year-to-date basis our consolidated earnings were $0.98 per diluted share for 2010 compared to $1.04 for 2009.

Now I’ll turn the discussion over to Scott Morris.

Scott Morris

Thanks, Jason, and good morning everyone. We had a good second quarter, our outlook improved for the full year of 2010 particularly with respect to our utility earnings. Cooler and wetter than normal weather this spring resulted in improved hydro-electric generation conditions. However we still expect below normal generation for 2010 due to low snow pack and precipitation last winter.

Given the improved hydro-electric generation we expect lower power supply costs and an increased benefit under the Washington Energy Recovery Mechanism for 2010. The improvement in the second quarter has partially offset a challenging first quarter due to one of warmest January to March periods on record. As such, we are confirming our 2010 earnings guidance with the expectation that we will be in the lower half of our consolidated guidance range.

Because of the warmer weather in the first quarter, residential electric use per customer was down 7% and residential natural gas use per customers was down 12% as compared to the first half of 2009. Commercial use per customers decreased 5% for electric and 16% for natural gas over the same period last year. We will continue to execute on our regulatory strategy to recover costs and capital investments in our utility business.

We reset general rates in each of our jurisdictions in the past year. In March we filed general rate cases in Washington and Idaho. In Washington, the commission has established a procedural schedule for staff and intervener testimony due in early September, our rebuttal due in early October and hearing is the first week of November. The commission has up to 11 months from our initial filing to review the case and issue a decision.

As you know in July, we reached the settlement in the Idaho general rate case. The Idaho settlement is designed to increase annual base electric revenues by $21.2 million and increase annual base natural gas revenues by $1.8 million. If approved by the Idaho commission new rates would become effective this October. And we are planning to file a natural gas general rate case in Oregon by the end of the third quarter.

Employment remains suppressed in most of our service area after cut backs in the construction and forest products, mining and manufacturing sectors although the pace of decline has slowed in the last twelve months. The job market in Spokane and Coeur d'Alene slowed later in the cycle than in the United States as a whole, while Medford has been more in line with the nation on average.

However both Spokane and Coeur d'Alene are coming out of the cycle a little later which is typical of these areas and national recessions although this is an atypical recession. Unemployment rates in June were 8.5% in Spokane, 9.6% in Coeur d’Alene and 12.2% in Medford, Oregon compared to the national average of 9.6%. The housing markets in Coeur d’Alene and Medford have had a little bit of a higher foreclosure rates than the national average.

The housing market in Spokane had a foreclosure rate well below the national average. We are committed to continuing our investment in utility infrastructure with a focus on increasing capacity and maintaining or/and improving our reliability. Utility capital expenditures were $80 million for the first half of the year. We expect capital expenditures to be $210 million for 2010 excluding the cost for our projects associated with stimulus funding.

But now I’d like to turn this presentation over to Mark Thies, and Mark will provide details on the performance of our businesses, liquidity, financing activities, and earnings guidance.

Mark Thies

Thank you, Scott and good morning everyone. For the second quarter, Avista utilities contributed $0.43 per diluted share compared to $0.46 per share in the second quarter of last year. This is primarily due to an increase in interest expense, increased other operating expenses and increased depreciation and amortization partially offset by an increase in gross margin. The increase in gross margin was primarily due to the implementation of general rate increases as Scott mentioned as well as higher retail loads particularly for natural gas.

On a year-to-date basis, our utility operations contributed $0.94 per diluted share compared to a $1.2 in 2009. The decrease was primarily due to a decrease in gross margin, an increase in interest expense and an increase in depreciation and amortization. The decrease in gross margin was primarily due to warmer weather as Scott mentioned earlier that reduced retail loads during the first quarter partially offset by the implementation of general rate increases.

These negative impacts were partially offset by a decrease in other operating expenses and taxes other than income tax.

During the first half of 2009, we carried higher average balances under our committed line of credit at relatively low interest rates. Last September, we refinanced these borrowing with the issuance of first mortgage bonds and historically favorable long-term interest rate.

This did result in increased interest expense for the first half of 2010 as compared to the prior year. Our quarterly and year-to-date earnings continued to be limited by regulatory lag. This is due to a delay in the recovery of incremental capital investments and increasing operating expenses. As Scott mentioned earlier, we will continue to file rate cases to recover our costs on a timely basis.

For the first half of the year, we absorbed $2.8 million under the Washington Energy Recovery Mechanism as compared to $4.1 million for the first half of last year. We expect to be in a benefit position in the 90% customer, 10% company sharing band under the Energy Recovery Mechanism by the end of 2010. This is due to lower wholesale electric and natural gas fuel prices, then the amount included in base retail rates partially offset by below normal hydro-electric generation for the year.

Advantage IQ’s net income attributable to Avista corporation for the second quarter and first half of 2010 increased as compared to last year with an earnings contribution of $0.03 per diluted share for the quarter and $0.05 on a year-to-date basis. The increase was primarily due to the acquisition of Ecos last August.

Advantage IQ’s earnings continued to be moderated by low short-term interest rates and slow organic growth primarily due to the economy. Advantage IQ’s revenue for the first half of the year increased 39% as compared to the first half of last year totaled $49.2 million. The increase in revenues was primarily due to the third quarter acquisition of Ecos. We had $0.01 per share net loss in other businesses for the first half of the year.

Consistent with the prior year, the net loss was primarily due to the losses on long-term venture fund investments. At the end of June, we had a combined $336 million of available liquidity under our $320 million committed line of credit, our $75 million committed line of credit and our $50 million accounts receivable financing facility. Later in 2010, we are planning subject to market conditions to re-market or refund with a new issue $83.7 million of our pollution control bonds that we repurchased in 2008 and 2009.

We expect to issue up to $45 million of common stock in 2010 to maintain our capital structure in appropriate level. We have a sales agency agreement to issue up to 1.25 million shares of our common stock and in the second quarter we issued 435,000 shares of common stock for $8.8 million under this agreement. As Scott mentioned, we are confirming our 2010 guidance for the consolidated earnings to be in the range of $1.55 to $1.75 per diluted share and we expect to be in the lower half of this range.

This is an improvement from the end of first quarter of 2010 when we are at the low end of our consolidated guidance range. As the outlook for Avista Utilities has improved in the second quarter primarily due to lower power supply costs and improved hydro conditions. We expect a contribution from Avista Utilities in the range of $1.45 to $1.60 per diluted share for 2010.

This assumes the implementation of the general rate increase in Idaho on October 1st as provided for in the July 2010 settlement subject to Idaho Commission’s approval. Our outlook for Avista Utilities also assumes normal precipitation and normal temperatures for the remainder of the year. Our guidance assumes a benefit under the Energy Recovery Mechanism due to lower power supply costs in the level of authorized and retail rates.

We continue to expect advantage IQ to contribute in the range of $0.10 to $0.13 per diluted share. Although, we are not changing our guidance for other businesses between a breakeven and contribution of $0.02 per diluted share, we may experience a slight loss based on the results for the first half of the year. I will now turn call back over to Jason.

Jason Lang

Thanks Mark and now we will open this call up for questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Brian Russo from Ladenburg Thalmann.

Brian Russo - Ladenburg Thalmann

Just to clarify on the guidance and the comments, I guess in the first quarter starting to be at the lower end, now you're at the lower half. So how should we look at the range you've laid out for Avista Utilities? Would you imply you're kind of in the midpoint of that at least off the lower end of the $1.45?

Mark Thies

Well again Brian in the first quarter we actually said the low end for both the utility and the consolidated guidance and so we have returned with this to our guidance of a $1.45 to $1.60 for the utility with no comment with respect to where in the range. We did see improved conditions due to hydro and that improved our position within the year.

Brian Russo - Ladenburg Thalmann

What was the ERM impact in 2Q?

Mark Thies

Within 2Q we are at $2.8 million at the end of the second quarter and that compared to $4.1 million last year. Again we reset rates each year so the comparability relative is different.

Brian Russo - Ladenburg Thalmann

But in the first quarter of 2010, you absorbed $1.2 million, correct?

Mark Thies

Yes.

Brian Russo - Ladenburg Thalmann

And that implies in 2Q you then absorbed an additional $1.6 million.

Mark Thies

Yes, that was correct.

Brian Russo - Ladenburg Thalmann

And just to understand kind of the dynamic of hydro-sensitivity to you guys on a quarter-by-quarter basis because it seems to be differences between some of your other neighboring utilities with hydro. You guys are net sellers of hydro in the second quarter, is that correct?

Dennis Vermillion

Generally, that’s correct during the run-off period, we would be net sellers.

Brian Russo - Ladenburg Thalmann

So then the reversal of the ERM into I guess an unquantified positive position by year end, is that in the latter half of the year you'll run your fossil fuel plants or buy power on the market, which could be below the fuel rate embedded in rates? Is that correct?

Mark Thies

Yes, that’s correct Brian. Primarily due to continued low natural gas prices.

Brian Russo - Ladenburg Thalmann

I think you mentioned in your press release that you still are experiencing regulatory lag. And I was just wondering, several quarters ago you kind of laid out 70 to 90 basis points of kind of disallowed costs and then 60 to 80 basis points related to just inherent lag in O&M and capital due to a historical test year. The second year in a row of back-to-back rate cases in all three of your jurisdictions, are you able to close the gap on any of those items?

Mark Thies

While we may see some slight improvement, we haven't finished, we do have a proposed settlement agreement in Idaho, we don’t, in Washington still. On the capital a lot of that depends on at what point with the historic texture as we continue to spend $210 million of capital and have approximately $95 million to $100 million of average depreciation, we still are having lag there.

So, we continue to work to get forward capital, but that will just depend on where we end up. If we continue using the historic text years and don’t get forward capital, we'll still have that lag.

From an operating expense perspective, we see opportunities to narrow that gap as we continue to work with the commissions and the staff to recover the costs that we see but until we get settlements in each of those, it’s hard to say, so we do continue to expect lag as we look forward.

Brian Russo - Ladenburg Thalmann

Are you currently in settlement discussions in Washington?

Scott Morris

Brian, part of the proposal is always to have kind of a settlement discussion and we have started those discussions, but nothing really to report in Washington.

Brian Russo - Ladenburg Thalmann

Just can you remind us of the 2012 valuation review for Advantage IQ per the agreement you signed in the Cadence acquisition?

Mark Thies

Well, the Cadence inside partners has put rights in both July of 2011 and July of 2012 and under the contract we have a valuation expert that will come up with the valuation and they do as well. But that depends on whether the party, A; nothing occurs between now and then that would have a valuation for advantage and be that the party inside partners wants to put the shares back, that’s an option at their behalf, there is no requirement there. So, we can't determine what they will want to do at that time.

Brian Russo - Ladenburg Thalmann

So can you just give a little bit more insight on what would happen if those Cadence insiders put their shares back to the company? Would you guys be obligated to match that with cash, I guess?

Mark Thies

The obligation is of the Advantage IQ, not the corporation. So, we would have to make a determination, the Board of Avista would have to make a determination as to whether they would want to put the cash in to repurchase those shares or if they would look to seek an additional party to come in and step into that position. So, there are options, it’s not a requirement on the corporation’s behalf to do anything with that.

Brian Russo - Ladenburg Thalmann

Is there a current value for those shares or is that part of the whole valuation analysis?

Mark Thies

We record as a liability in our 10-Qs, a current valuation at the time based on an outside party’s valuations. And that’s recorded every quarter.

Operator

Your next question comes from the line from [Matt Fallon] from Talon.

Unidentified Analyst

Just wondering in the press release where you lay out $45 million of stock in 2010 and then your sales agency agreement, the 1.25, I'm just wondering where the remainder of the equity would come from?

Mark Thies

We have authorizations from both the commissions and the Board beyond the 1.25 million shares to be able to issue up to an additional 1.8 million shares, we just don’t have a particular agreement to any sales agency or other agreement in which we would do that. But we have the ability to do that at any time, we would have to go through some procedural workings to enter into agreements to do that. So, we can either work to extend an existing agreement or enter into new agreements and which we could issue up to 1.8 million shares beyond the 1.25 million agreement.

Unidentified Analyst

And that's something you can do fairly quickly, I guess?

Mark Thies

Yes.

Operator

(Operator Instructions) Your next question comes from the line of Jennifer Sireklove from McAdams Wright Ragen.

Jennifer Sireklove - McAdams Wright Ragen

I just had a question about Advantage IQ. I want to go back to your comment about slow organic growth. I was just curious to what extent that's just a function of the economy and to what extent that there are things within that group that you could be doing now to sort of improve on that slow organic growth.

Scott Morris

Jennifer, the business really continues to be an exciting business for us. The organic growth piece of it, in our traditional bill pay as you know we were able to sign up new customers, but a lot of times as we did expense management as the retail sector expanded, we got a lot of growth just because Starbucks is building more stores or perhaps Lowe’s is building more stores.

So we got some of that growth just because of the economy and obviously all of that has slowed because of the retail sector. So, while the expense management piece of our businesses has slowed, but it’s still growing. We are still adding accounts, there is other parts of our business that are really experiencing some nice growth, I would say more of our consulting services procurement business for example continues to be a high growth area for us.

And also the Ecos business has been wonderful. As you know with Utility spending more dollars on energy efficiency, the Ecos business continues to thrive and we continue to push the Ecos business not just in the west, but it’s expanding across the country. So, while there are pieces of the business that have slowed, there’s others that are growing in quite a fast pace. So overall we are very pleased with the business.

Jennifer Sireklove - McAdams Wright Ragen

So on net you would say that it's slow, but there are pieces within that that are doing quite well?

Scott Morris

Yes, I would say that our traditional expense management business has slowed, but still adding net accounts but there are other pieces of the business that continue to expand and grow quite nicely. And then again of course having interest rates at less than 1%, traditionally we enjoy to have our float revenue and our float revenue has taken a hit over the last couple of years and as interest rates rise, that will improve. As you know that margin drops right to the bottom line.

Operator

And your final question comes from the line of Jim Bellessa from D.A. Davidson.

Jim Bellessa - D.A. Davidson

Going back to the discussion about the guidance range and the point that you haven't characterized at what end of the range you will be for Avista Utilities, but just implied in the other comments it suggests that you need to be above the end of the range. Is that correct? Because you're saying, for example, that you may have a loss at the other segment.

Mark Thies

No, if you look at our ranges that we talk about, the consolidated range is $1.55 to $1.75. We expect to be in the lower half of that range. Okay? Utility is a $1.45 to $1.60 and we are not commenting directionally there. We previously said in our prior call that we would be at the low end of the utility range and we have removed that low end as we have seen improved conditions within the utility. Advantage IQ stays the same and then other is very nominal, it’s zero to a positive two in the range we may experience a slight loss, very nominal amount. That should not affect the overall range of any significance, Jim.

Jim Bellessa - D.A. Davidson

Good, I now understand better because you're off the bottom end of the utility range. You're above the bottom end from what you just said.

Mark Thies

We were, we have seen improved utility conditions, because of the hydro as Dennis mentioned.

Jim Bellessa - D.A. Davidson

And you're talking about the ERM benefit in this second half or maybe even in the fourth quarter. Do you have that natural gas cost hedged?

Scott Morris

Yes, we have a substantially all of our current position hedged or still I think about 10% remaining.

Jim Bellessa - D.A. Davidson

If you were to guess how the parties in Washington were coming together, would you say it's a favorable discussion in terms of a settlement agreement? Or are you just still far apart and you can't even tell which way it might go?

Scott Morris

We’ve just begun discussions and I would just say that as usual the parties have come together to have a discussion and want to see where it goes. It’s just hard to say.

Jim Bellessa - D.A. Davidson

In the other segment, you have this long-term venture fund investment or investments. Do you need this and more times than not, it seems to be a drag on results. Am I just not noting all the times it does improve in terms of mark-to-market or is it true that it keeps lagging?

Mark Thies

You're absolutely accurate that we have continued to have negative results. We do in certain of them, we have seen some positives, we have a manufacturing company in California, small manufacturing that has seen improved results and some of the funds continue to have some of the historical ends. Due to the slow economy we continue to see negative, so on a net basis through the first half we are a $0.01 negative, but we don’t expect that to be material. Last year we had a significant write off. You may recall in the fourth quarter that caused our results to be significantly worse, but we don’t expect those issue.

Scott Morris

And again Jim, remember those investments were made in the late 1990.

Operator

And there are no further questions in the queue.

Jason Lang

Well, I'd like to thank everyone for joining us today. We certainly appreciate your interest on our company. Have a great day.

Operator

Thank you for your participation in today's conference. This concludes your presentation and you may now disconnect. Have a great day.

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