PG&E Corporation Q3 2007 Earnings Call Transcript

Nov. 1.07 | About: PG&E Corporation (PCG)

PG&E Corporation (NYSE:PCG)

Q3 2007 Earnings Call

November 1, 200711:00 am ET

Executives

Gabriel Togneri - IR

Peter Darbee - Chairman, CEO and President

Bill Morrow - President and CEO of Pacific Gas and ElectricCompany

Chris Johns -SVP and CFO

Christopher Warner – Legal Counsel

Analysts

Greg Gordon – Citigroup

Dan Eggers - Credit Suisse

Jonathan Arnold - Merrill Lynch

Lasan Johong - RBC Capital Markets

Steve Fleishman - Catapult Partners

John Kiani - Deutsche Bank

Ashar Khan - SAC Capital

Patrick Forkin - Tejas Security Group

Michael Lapides - Goldman Sachs

Reza Hatefi - Polygon Investments

Operator

Welcome to the PG&E Corporation third quarter earnings conferencecall. At this time, I would like to pass the conference over to your host, GabeTogneri. Thank you and have a good conference. Go ahead Mr. Togneri.

Gabriel Togneri

Good morning. Thanks for joining our call to discuss thirdquarter earnings. Let me remind you, this is a simultaneous webcast andconference call and all participants are in listen-only mode. A replay of thewebcast will be available from the PG&E Corporation homepage after thecall.

Our earnings press release went out earlier today and it isposted on our website along with the supplemental tables including Regulation Greconciliations. We’ve also provided these materials in our 8-K reportfurnished to the SEC this morning, and we do plan to file our joint Form 10-Qreport for the corporation and for the utility with the SEC today.

Before we begin the discussion, I’ll remind you our preparedremarks and the Q&A session contain forward-looking statements based onassumptions and expectations that reflect information currently available tomanagement.

As we discussed in more detail in our press release and SECreports, actual results may differ materially from those forward-lookingstatements. You should review our SEC reports to obtain additional informationand to better understand the various factors that can influence future results.

Peter Darbee, Chairman, CEO and President of PG&ECorporation; Bill Morrow, President and CEO of Pacific Gas and Electric Company;and Chris Johns, Senior VP and CFO of the corporation; will take us through thequarterly results and other highlights. Other key members of our team are alsohere to participate in the Q&A.

And with that, I’ll turn it over to Peter.

Peter Darbee

Thanks, Gabe. We’re pleased to be reporting another strongquarter this morning. Total net income was $278 million or $0.77 per share.Given the strength of our year-to-date performance, we now expect 2007 earningsto come out in the top half of our guidance range for the year. Additionally,we’re reaffirming our 2008 guidance.

As you know, we continue to focus on our vision to transformPG&E into the leading utility in the United States. First and foremost, that meansworking to improve service to customers doing it better, faster and more cost effectively.We’re pleased to report that we recently took another big step towards thatgoal. Early last month, we executed a major transition to a new system thatgives our field teams more efficient and more effective tools and processes.Bill Morrow will talk about this milestone in more detail in a few minutes.

Even with the success, however, we continue to have muchmore to do. As you’re aware, the goals we set for business transformation areaggressive and challenging and Chris Johns will speak more to this point in afew minutes.

That said, we’re firmly committed to moving forward on thepath that we’ve set. We’re firmly committed to the vision and we’re firmlycommitted to delighting customers, energizing employees and rewardingshareholders.

A key part of that vision, as we’ve discussed many times, iscontinuing to build our profile as an environmental leader. On that front, I ampleased to report that so far this year, we have signed contracts for over 800megawatts of new, renewable energy resources.

On our last call, we announced a major agreement with SolelSolar Systems to purchase over 500 megawatts of clean energy from a newfacility located in the Mojave Desert. We’re continuingour support of solar thermal development. In fact, over the next five years, weare aiming to build a solar thermal portfolio of about 2,000 megawatts and thisis equivalent to four new gas-fired plants on the scale of our gateway station.

Earlier this week, we also announced 150-megawatt contractwith enXco Wind Energy. We also accelerated our arrangements to begin receivingbiogas in 2008. This will be the first delivery of biogas under a new stateregulation, which established biogas as a renewable resource.

As you know, one of the keys to expanding renewable energyis creating the electric transmission to support it. We’re aggressively work onthis front with transmission investments like our new central California cleanenergy line or C3ET, which will provide the necessary transmission capacity toaccess the Tehachapi Wind Region. We are making great progress towards ourrenewable goal and we expect to have deliveries and contracts for futuredeliveries that will total at least 20% by 2010.

With that, I would like to turn it over to Bill Morrow foran update on our operations.

Bill Morrow

Thank you Peter and good morning, everyone. This pastquarter was particularly important for us because we met several milestonesthat confirm one, we’re doing the right things for our customers; and two,we’re making progress on a platform for an even better future.

I’ll touch on three areas: our recent customer satisfactionreport from JD Powers, a major automation and centralization milestone, and anupdate on the SmartMeter project.

JD Powers has completed their gas residential surveys acrossthe nation and we’re thrilled to report that we’ve moved from the 20th positionlast year to #5 this year. This top docile ranking was achieved with gains innearly every measured component. Most improved was the company image andcommunications with our customers. This is the last of the four-benchmarksurveys for this year. As we previously reported, our electrical residentialperformance improved and we’ve made our biggest gains towards the leadingutilities in the United Stateswith our gas business and our electric business segments. Here again, we feelthere’s still much more to do and we have many other improvement initiativesunderway.

Just one example I would like to share with you is our newcustomer connection process. During the quarter, we completed the rollout ofour new process and we’re encouraged by the results that we’re seeing so far.We’ve reduced the number of internal handovers by two-thirds, and we’veshortened the time for us to install the service to half of what it was before.

Now, as I believe you’re aware, there are many processreengineering efforts underway in the company, but earlier last month, we metone of our more important and likely the largest reengineering milestone in thehistory of the company. We moved from a labor-intensive complex set ofprocesses around how we initiate, plan and schedule our work to one thatintegrates a standard, highly automated and centralized approach. Field crewswill have materials and supplies delivered just in time and tailored to theirjobs. Dispatch and work resource coordination centers will be able to moreeffectively use our field forces. Managers, for the first time, will haveimproved tools to track and manage productivity and quality. We expect to seeimproved effectiveness with a lower cost structure, as we perfect and refinethis process.

Moving on to our SmartMeter project. Our project is onschedule and we completed the re-platforming of our customer care and billingsystem. Roughly 10 million SmartMeter will be sending large volumes of data toa centralized source. We need to be able to store, collate, cross-reference toa given tariff and then format the customer bill with this data. So thiscutover will provide a more powerful platform and despite the complexity of thetask and I’m happy to report that our IT team completed this in a near flawlessmanner. During the quarter, we also ramped up the meter deployment and were ontrack to have about 240,000 SmartMeters deployed by the yearend.

Now, as we reported last time, we’re evaluating someenhanced technology. particularly, around the communications portion of thattechnology. We selected two vendors for our pilot test and these are being setup as we speak. The pilot test will focus primarily on three areas. Thecommunications platform using an RF mesh network; a home area network interface;and solid-state technology with integrated disconnect capability. We expect theinitial field test to continue through the first quarter of ‘08 and if alllooks good and we have the commission’s approval, we’ll expect to seedeployment begin sometime in early ‘09.

We intend to file an application for the increased cost withthe CPUC before the end of this year and we expect a decision from themsometimes toward the end of 2008. So in the meantime, the existing businesscase remains valid with the technology that we have and we will continue todeploy this as scheduled. Once we approve the newer meters, we do not intend toretrofit those already deployed unless there obviously is a compelling businesscase to do so.

So we frequently reflect back on the transformation progressof our company and we now have about two years of experience with numerousimprovement initiatives completed. The lesson on what has worked well and wherewe could improve will help us calibrate the plan going forward and we’re doingjust that.

So let me turn this over to Chris who can share a little bitmore of the numbers with you.

Christopher Johns

Thanks, Bill. I’ll begin by discussing our third quarterresults and guidance and then update some key regulatory developments. For thethird quarter, PG&E Corporation earned $278 million or $0.77 per diluted common share on both a GAAP andnon-GAAP basis. This compares to $393 million or $1.09 per diluted share on aGAAP basis and $310 million or $0.86 per diluted share on a non-GAAP basis forthe third quarter of 2006.

Looking at earnings from operations, a primary driver of ourearnings is rate-based revenue, which has increased by $0.09 per share over2006 as a result of our general rate case and FERC Transmission owner rate casedecisions earlier this year. As you can see from table 4 of our supplementalearnings tables, there were a number of nonrecurring type items for both 2006and 2007 that resulted in the lower quarter-over-quarter results.

First, there were a few items positively impacting earningsin 2006 that did not recur in 2007. These include realization of a tax benefitfrom utilization of capital loss carry-forwards, recovery of energy supplierlitigation costs and long-term disability plan savings. These items togetheraccounted for $0.10 per share of a decrease in earnings compared to 2006.

Next, the delayed billing investigation decision had anegative impact of $0.02 per share. In September, PG&E was ordered to refundaround $35 million to customers. The $0.02 per share impact represents theincremental charge in excess of the amount previously reserved. Increased stormand outage-related costs and lower gas transmission revenues compared to thethird quarter of 2006 each had an impact of about $0.01 a share.

Miscellaneous items accounted for further negative impact of$0.04 per share. This reflects a host of different items including increasedspending on business transformation efforts and a higher run rate on expensesfor such items as hydro re-licensing activities and dry cast storage at Diablo Canyon. These increased expenseswere anticipated and were mentioned in last quarter’s call.

Finally, looking at the GAAP comparisons, let me remind youthat there were two positive items impacting comparability in the third quarterof 2006 that added $0.23 of EPS. In the first three quarters of 2007, earningsfrom operations and GAAP earnings have been the same.

Moving on to guidance, given our strong performance so farthis year and expectations for the fourth quarter, we are confident we willdeliver earnings in the upper half of our previously-stated guidance range for2007 of $2.70 to $2.80 per share. Considering our year-to-date performance,this would mean operating earnings of between $0.53 and $0.58 per share for thefourth quarter. This fourth quarter performance would be comparable with thefourth quarter of 2006, considering the positive impact of our GRC and TL ratecases.

For 2008, we’re reaffirming our guidance of $2.90 to $3 pershare. We also continue to target an 8% compound average annual growth in EPSfrom operations through 2011. As always, a reconciliation of our guidance for2007 and 2008 earnings per share from operations to projected GAAP EPS can befound in our supplemental earnings materials.

Our guidance for 2007 and 2008 EPS from operations and ourtarget growth rate assume that we continue to have a CPUC authorized return onequity of 11.35% and we earn at least 12% on our FERC jurisdictional business.It also assumes that we achieve our projected rate base of approximately $16.9billion for 2007 and $18.7 billion for 2008 while maintaining our rate-making capitalstructure at 52% equity.

Our guidance and target growth rate also assumes that we willbe successful in our initiatives to become more efficient and drive additionalcosts out of the business. As Bill mentioned, we have just rolled out a majorinitiative to automate the scheduling and execution of work in the field.Realizing the expected benefits from that release and other operationalimprovements is vital to reaching our 2008 forecast and 8% growth rate.

We, like other companies, are currently facing some growingchallenges in our business environment. These challenges include costs for suchitems as materials, permitting, and labor, rising at a pace faster than whatwas included in our general case as well as increased reliability demands andexpectations from an aging infrastructure. These rising cost and demands on ourbusiness increase the pressure on our initiatives to achieve greateroperational efficiency.

We are currently in the midst of a top-to-bottom review ofour plans for 2008 through 2010 and this includes a full review of ouroperations and spending levels as well as the timing and level of benefits weexpect from our operating initiatives and the impact of regulatory orders. Theidentification of broader operational savings in the inclusion of energyefficiency incentives may be necessary for us to be able to achieve ourtargeted growth rate. Additional capital investment opportunities continue torepresent earnings upside.

Just to be clear, it would not be advisable at this time toconsider potential earnings from energy efficiency incentives as incremental toour 8% target growth rate. We’ll continue to explore additional efficiencyefforts and business opportunities to offset the increasing costs in ourbusiness and we’ll also look to new initiatives and other opportunities foradditional earnings contributions. We plan to provide a complete update in thefirst quarter of 2008.

Now, I’ll move on to a couple of regulatory items ofinterest. On September 20th, the commission approved the shareholder incentivemechanism for energy efficiency. While we view this as a very constructivedecision intended to put energy efficiency on par with supply side generationinvestment, yesterday we filed a petition to modify that decision. Despite thepositive policy, there are a number of technical issues involving the timing andmanner in which the utility’s performance is evaluated that we believe wouldpreclude PG&E from booking any earnings from incentives until the end ofthe three-year cycle.

We’ve been involved in constructive dialogue with the commissionand along with the other utilities in California,we seek to add additional language to the decision, which would give us thecertainty necessary to recognize some portion of the incentives or penalties onan annual basis.

Under the current incentives structure, we would have theopportunity to earn a maximum pre-tax incentive of $180 million over thecurrent three year 2006 to 2008 program with a similar structure extending intothe 2009 to 2011 energy efficiency program cycle. Risks and rewards under theincentive program are symmetrical. We’ll keep you posted as the proceedingsprogress.

On other matters, we’re on schedule to receive a final decisionon our cost of capital case by the end of the year. We would expect to see aproposed decision in the next few weeks. As a reminder, this decision willpertain only to our cost of capital for 2008 and will not include the automaticadjustment mechanism, which will be contemplated in a separate case before the commissionin the early part of next year.

With that, I would like to hand it back to Peter.

Peter Darbee

Thanks, Chris. I’m going to close with a few comments on thedirection of our company and the industry in general. Increasingly, we areseeing the role of the utility beginning to expand. Not too long ago, we as anindustry were solely focused on providing a commodity. While this remains atthe core of our business today, customers are increasingly expecting more. Webelieve they’re beginning to look for companies that are thinking about suchissues as global competition for resources and environmental pressures foralternative energy and we see this as a tremendous opportunity for PG&E.

Our customers are challenging us to provide them asustainable energy future and we are rising to this challenge. While otherutilities are still in the business of selling as much power as they can,PG&E’s leading the industry in adopting a new paradigm. We’re not only inthe business of providing power that is clean and reliable, we’re helping ourcustomers explore opportunities to use less of our product. We see that asproviding them with higher value-added and they’re responding that they agree.This is evident in our improving JD Power scores.

Decoupling, combined with the recent energy efficiencyincentive mechanism, gives us a true motivation to make our customers successfulin becoming more energy efficient. We are working together to find ways toreduce our industry’s environmental footprint. We have worked hard to supportand shape carbon legislation at the state and federal level. We continue tomake our generation mix even cleaner and have fostered the development of newtypes of renewable generation resources.

Additionally, we are seeing utility customers demand betterways to help them manage their energy usage. Here again, we’re at the forefront.As Bill mentioned, we’re exploring the possibilities of upgrading our SmartMeterprogram to enable exciting new products and services through which we can helpour customers take control of their energy usage.

As customers are demanding more from their energy providers,we expect the industry will see changes in the way we procure, deliver andconsume energy.

In short, at PG&E, we’re not only developing strongresults from our core operations, we are firmly focused on the future andhelping to shape the direction of the industry. We’re doing it in a way thatfits with what our customers are increasingly seeking.

With that, I would like to open it up for questions.

Question-and-AnswerSession

Operator

Our first question comes from Greg Gordon - Citigroup.

Greg Gordon -Citigroup

Just to review your comments, you’re seeing meaningfulincrease in the underlying cost of doing business in the core utility. Therefore,just to translate what you said, you’ve got a very wide range of potentialearnings outcomes depending on how successful you are in both executing energyefficiency -- obviously if the accounting is correct -- and the transformation program. But giventhe creep you’re seeing in overall of the business, all things being equal, youneed a higher level of execution to achieve and/or beat your growthaspirations. Is that what you’re trying to tell us?

Christopher Johns

Basically, what we’re reiterating is the 8% growth and thatin light of some of the underlying cost increases we’re seeing, we want totemper folks from adding automatically any regulatory order that would allow usincreased energy efficiency incentives above and beyond that 8%.

So we’re taking a look at what those cost drivers are andthen quite frankly, we’re looking at what is going to be that final order andwhat level of earnings with that energy efficiency program give us and whatwill our cost of capital proceeding give us at the end of this year, so that wecan give everybody a better update in the first quarter of next year.

Greg Gordon -Citigroup

But there is also a larger question in that. There’s a hugerange of potential outcomes on the effectiveness of transformation, which isembedded in the communications you’ve given us in the past, right. And you’veindicated that, 100% of achieving the high end of those potential outcomes is,in fact, not necessarily baked in to the 8% guidance range.

So, I’m trying to understand, is it the energy efficiencygain, the energy efficiency earnings uplift that would be absorbed bypotentially higher costs or the cost increases you’re seeing even more direthan that and also into some of the potential upsides from executing at thehigh end of your guidance on transformation?

Christopher Johns

I think I understand the question that you’re asking andwhat I would say is that, our transformation efficiency programs are continuingto move forward. Some of those programs were realizing better than expectedbenefits and some of them less than expected benefits. As we always do, we’recontinuing to evaluate those.

I’ll remind you that when we provided the details around thetransformation programs a year ago that we had baked in some piece of thosebenefits in the 8% growth and that was what we included during that timeframe.

We need to continue to evaluate those differenttransformation initiatives that we’ve got going on in light of these increasingcost pressures that we’re seeing, and we’ll give you a more detailed analysisof those results because right now, we’re going through a top to bottomevaluation of those programs and we’ll have a little bit more information inthe first quarter.

Operator

Your next question comes from Dan Eggers - Credit Suisse.

Daniel Eggers -Credit Suisse

There’s been a lot of talk from the generators aroundpushing forward with this capacity auction in California.I was wondering if you could just stake out your perspective as far as how youfeel that should work, whether it should work and what potential implicationscould be to customers?

Christopher Warner

This is Chris Warner from the law department. Yes, indeed,we’re participating with the stakeholders in the capacity auction issue. Webelieve there’s still more work to do on that approach. We’re not sure thatapproach achieves everything we would like to see. But we do expect to continueto work with various parties. We do think it’s very important to provide andmeet the goal of providing certainty for a new generation in California.

Daniel Eggers -Credit Suisse

Along the lines of the generation needs, thoughts or an updateon the procurement plan, when we could we could get updates on what all is goingto layer into that and what PG&E’s role could be in developing newgeneration?

Christopher Warner

We definitely have a procurement plan in front of thecommission and we do expect the commission to be acting on that in the nearfuture. It does include a mix of power procured as well as utility-ownedgeneration and we do believe that provides a good approach for assuringreliable and adequate supplies going forward.

Peter Darbee

Let me just add on top of that that we continue to seeparticipation in the auctions for new generation as a key opportunity forgrowth for the company or certainly a significant opportunity for growth. So inthe past, we have participated in them and are building a material amount ofnew generation for the State of Californiaand our territory and we continue to view that as an opportunity and view it ina similar way than we have in the past.

Daniel Eggers -Credit Suisse

Any more clarity on when we could see a response from thecommission on the procurement plan?

Peter Darbee

No. I think we expect sometime in the first quarter of nextyear, if not a little bit earlier.

Daniel Eggers -Credit Suisse

So, in the next two to three months we should probably hearsomething is the right take away?

Peter Darbee

Well, again, the schedule is a little bit unclear in termsof the amount of work the commission still has to do to prepare its decisions.

Christopher Warner

And I should probably just remind everybody who’s listeningon the call this is a two-phase sort of procedure where the decision we werejust talking about, hoping to get in the next couple of months, would set thelevel of identified need and that would be the level at which the variousoptions for providing that need would come in.

Operator

Your next question comes from Jonathan Arnold - MerrillLynch.

Jonathan Arnold -Merrill Lynch

Good morning. Just wanted to revisit Greg’s question, justif I could. I believe, I heard you saythat unless you get the energy efficiency incentive order changed and findadditional cost savings, it’s going to be tough to make the 8% number. Did yougo that far?

Christopher Warner

No, Jonathan. I wouldn’t say that we went that far. Allwe’re saying is that as we go through our process of continually updating wherewe think we’re going to end up in our forecast for the next couple of years, wesaid that it wouldn’t be, at this point, the correct thing to do to just addthe energy savings incentives on to the 8% growth. That we may need to use someof that to offset some of our cost increases that we’re seeing, or we may needto use all of it. We have to look at what level that would be based on what thefinal order looks like and what the program looks like.

Jonathan Arnold -Merrill Lynch

But isn’t that the same as saying that if you didn’t get theincentives, then it would be tough to make 8%?

Christopher Warner

No. We’re not trying to imply that either. We’re just sayingthat we have to balance all of our efficiency programs and our transformationefforts and any regulatory orders and have to look at all of those items. We’rereconfirming the 8% and we said that earlier. Its just that we want to balanceall of those things in looking at how we get to the 8% and that we think thatit wouldn’t be the right thing to do to just automatically add the potentialbenefits of energy efficiency program to that 8%.

Jonathan Arnold -Merrill Lynch

I had a just one other small issue you mentioned you’d befiling the incremental cost on the SmartMeter program shortly. Can you justremind us, have you said how much you think that might be? I don’t recall.

Christopher Johns

We did not say how much that would be. We expect that wewill have to make a proposal as far as the dollars in that filing and so assoon as that filing gets put out, then we’ll go ahead and make sure thateverybody is aware what the dollars will be around that.

Operator

Your next question comes from John Kiani - Deutsche Bank.

John Kiani - DeutscheBank

Not to belabor the growth rate question, but if I thinkabout what you said earlier, which is that the underlying operating costsserved have increased since the rate case filing, could we think about it moreas a potential timing issue in that longer term, you would catch up and make upsome of that in your next rate case, because the cost structure would be muchmore reflective of the market reality.

Christopher Warner

Well, John, obviously when we go out and do the next ratecase, the rate case proceedings require us to look at what is our current coststructure at that time and what is our rate base look like at that point intime. And they will address that on an ongoing basis in the future. When we’retalking about here is we’ve really been addressing that timeframe between nowand the rate case in the next rate case. You’re exactly right. As we go intothe next rate case, whatever our current cost structure is at that point intime will be what is debated and what gets included in our rates after that.

John Kiani - DeutscheBank

Okay. And then can you remind me again what’s the latestyou’ve said about any additional pipeline investment opportunities in the Stateof California?

Peter Darbee

Really, what we’ve talked about is the Pacificinterconnector effort which is actually in Oregonand provides for a connection going from the north south pipe line over to Coos Bay and that I’m trying to think,Chris, what we’ve communicated in terms of the possible dollar opportunityassociated with that investment?

John Kiani - DeutscheBank

I actually mean aside from the Pacific interconnector?

Peter Darbee

We really haven’t spoken about specifically additionalcapacity adds within the state of California.

Peter Darbee

I think what we’ve said is to the extent that people developopportunities whether they are LNG or other pipeline opportunities in andaround the state, we would always want to look at any opportunities we may havethen to make sure that we have connections to those. But that we haven’tmentioned anything specifically around any specific projects.

Bill Morrow

We talked a little bit about BC renewables as well in thepast and that is still a project that is up in the air.

Operator

Your next question comes from Michael Lapides - GoldmanSachs.

Michael Lapides -Goldman Sachs

When I look at the average annual rate base that youpublished in your last investor presentation from October, so I think it’s page20 of that presentation, when I look at those numbers, can you just kind ofwalk through and this may be a little repeat, little repetitive, could you kindof walk through the major project that aren’t in these numbers? That could orcould not depending on approvals, wind up being incremental to what we’reseeing here on page 20.

Christopher Johns

I’d be glad to do that. The first one is the one is the onethat Peter alluded to which is the Pacific interconnector project and that is agas pipeline project in Oregon.We’ve been talking about it for a while. We did in this quarter make a filingwith FERC to start the regulatory process on that. And that would be about abillion-dollar project of which we would be a one-third owner.

In addition to that, what Bill just mentioned was on theelectric transmission side, we were approved by the commission to spend about $14million to $16 million over the next couple of quarters to investigate theopportunity to build a very large transmission line up into western Canada thatwould give us access to their wind power and potentially some hydro power upthere.

We don’t know exactly what size that would be at this pointor what our participation would be but the project could be, I think we’ve saidas much as $4 billion to $6 billion in the past as to how big that could be.But again, we’re just in the preliminary stages of looking at what that wouldlook like.

Peter Darbee

And I would add on that that we would work with partners andso we would have a fraction of maybe $6 billion.

Christopher Johns

We continue to look at other transmission opportunitiessimilar to that, we would go outside of the state and bring us access torenewable power. Finally, we’ve also talked about, in the past, the RFP thatChris mentioned which is pending before the PUC and that might us opportunitiesto own some additional base load generation through that process. We were successfulin the last go around on our long-term procurement to get a couple of plansapproved that we’ve been talking about, Gateway and Colusa, which are in ourprojections but for this next around to have additional generation.

We’ve also talked about in the past that we will continue tolook at opportunities to invest in renewable resources in the form of ownershipand in fact, in the latest RFP, we do leave that open for potential turnkeybids into that process where we might actually own some of the renewables.

So, those are the different things that we’ve been talkingabout that are outside of the base capital expenditures that we’ve beendisclosing previously.

Michael Lapides -Goldman Sachs

Can you kind of give us an update on what it costs to builda new combined cycle in northern Californiathese days? Just kind of on a dollar per KW range?

Christopher Johns

Our recent ones, we just went through and got the approvalaround the Colusa plants and the additional purchase power agreements and Ithink that they were in the range of about $900 to $1,000 per megawatt.

Operator

Your next question comes from Lasan Johong - RBC CapitalMarkets.

Lasan Johong - RBCCapital Markets

I hate to belabor the point, but on this energy efficiencything, if you didn’t have it and you weren’t going ahead, what would thecompound annual growth rate look like? Would it still be very close to 8%?Isn’t this six or half-dozen of the other whether you increase your production?

Christopher Johns

Lasan, I’ll just reiterate, all we’re telling folks is thatthat if we get the energy efficiency program incentives and the ability torecognize those on an annual basis, we don’t want people to automatically putthat in excess of the 8% growth. We reiterated that today. We’re still sayingwe’re going to be able to grow at 8% and that we have to look at all of thosedifferent items as to helping us to get there potentially, but we just don’twant people to go beyond that.

Lasan Johong - RBCCapital Markets

You’re not going to tell us what it would be without theenergy efficiency program? The growth rate?

Christopher Johns

Well, I think we’ve just said that we’re reiterating the 8%.

Lasan Johong - RBCCapital Markets

$158 million O&M cost increase. I think you said thatthere were three things business transformation expense, hydro re-licensing andsomething else, correct?

Christopher Johns

Are you referring to the quarter over quarter?

Lasan Johong - RBCCapital Markets

Yes. $158 million increase in O&M expense?

Christopher Johns

That is actually a series of items all of which are probablyabout $40 million or $20 million or less in different things and those includeincreases in labor costs, those include contracting costs. Implementation ofinformation systems, maintenance expenses, the OII delayed billing penalty thatwe got this quarter. It’s a myriad of different items that quite frankly wedetail and give pretty good detail in page 41 of our 10-Q that lays it out.

Lasan Johong - RBCCapital Markets

I’ll take a look at that. The SmartMeter, how many metersare left to install?

Bill Morrow

The program is of course to get up to about 10 million as Imentioned earlier. We are on target for about 240,000 at the end of this year.So the rest of them will come over basically about a four, four-and-a-half yearprogram.

Lasan Johong - RBCCapital Markets

So, you’re basically telling me about 9.76 million meterswill get these additional new features that you’re talking about?

Bill Morrow

Well, it depends, if we start deployment again, say in early‘09, then obviously its going to be a lot less than that. But it will still besubstantial. Again, I think the important point to recognize here is that as welook at our rollout, we’re going to take the existing technology and keep itcontained to certain geographies and so that way we can keep our maintenancespares down, the training for our field techs in order to where we can get theeconomies that we believe are still inherent within that.

The customer will see the benefit associated with, let’scall it, this first generation technology. We’ll see the operational efficiencyin terms of not needing a meter reader to be dispatched out there to read themeter. We’ll also have the improved reliability characteristics, which is aboutisolating a problem and knowing that everybody is back in service when ourtrucks are packing up and rolling out.

To go beyond that, with this new technology, again, thatwouldn’t really probably hit the customers until 2009, that’s when they aregoing to see more the idea of a kind of a demand response enhanced featurecapability set, they’ll see an in-home with home appliance, smart appliances,smart thermostats, a whole new level of service to be able to manage fromthere.

As I mentioned, we don’t plan to go back and retrofithowever many hundreds of thousands of meters would be of this first generationunless that incremental business case warrants us to do so.

Lasan Johong - RBCCapital Markets

The idea behind this new suite of features is to tie it intoyour energy efficiency program, is that kind of the way to look at it? Or isthis in preparation for deregulating California?

Bill Morrow

Well, it actually is a platform that’s quite interesting andI do really believe that, you know, we have yet to even kind of think of thefull potential that this platform is going to give us. The basics aboutoperational efficiency again, avoiding the meter reading are the biggest onesthat we can put on paper today.

The second round, when you look at the energy efficiency anddemand responses, the second category that we’ll get, another thing I wouldpoint out is that by putting in this communications RF mesh network, it enablesus to move into kind of the smart rig concepts that I know many of you havealready heard much about. But that is going to be fundamental for us to be ableto grow in that area. So as we see more of a distributed power supply area, aswe see different kinds of reliability techniques, this is going to help us to beable to deliver that.

Operator

Your next question comes from Steve Fleishman - CatapultPartners.

Steve Fleishman -Catapult Partners

Could you remind us when you expect a ruling on therehearing on the efficiency order?

Christopher Warner

It’s not a rehearing. It is a petition for modification andthose can take a number of months. We do hope that the commission will actexpeditiously on this petition, so we certainly would hope they would actsometime early in the year but again, there is a due process. There areopportunities for other parties to comment so it could take a number of months.

Steve Fleishman -Catapult Partners

Secondly, in terms of the cost pressures that you’re seeing,could you just be maybe a little more specific, what areas those are in and howthey’re different than what you wouldhave anticipated under normal conditions? What’s really different now? Justinflation is higher?

Christopher Johns

You know, it goes probably a little bit beyond just whetherinflation is higher. We, like a lot of other utilities and other companies, areseeing a lot of the material costs, so whether it’s copper, cement, some of thebase materials that go into a lot of the capital projects is rising. Some ofthe contractor costs that we’re incurring for maintenance and other parts ofour programs, external contractor costs, labor costs have gone up quite a bit.We’re seeing permitting costs rising also. So it is quite a myriad of differentthings. We have our own labor costs, which we have a good handle on, but we’reseeing increases in costs outside of that in the contracting that we’re doingexternally.

Operator

Your next question comes from Ashar Khan - SAC Capital.

Ashar Khan - SACCapital

Chris, I just want to go back and understand kind of thevariances. As I look at you’re saying you’ll be at the upper end of theforecast for this year and then you’re repeating your forecast for next yearwhich is, if I’m correct, still without energy efficiencies -- and correct meif I’m wrong -- that implies if I go to the upper end of the forecast, nearlylike a 7% growth rate in earnings from around the upper point of this year tothe upper point of next year.

We have rate-based growth of about 10.6% next year from thefigures that you gave us, the latest today. I’m just trying to understand the commentsthis morning. Is it that the savings that you anticipated as part of the rateplan are falling lower than what you had in your assumptions which is causingthe shortfall, or are you expecting a significantly different cost of capitaldecision at the end of the year which is going to lower the returns and hencethese deltas are not going to hold up in terms of realizing the earnings whichshould come in for a much higher rate base addition next year, and what youhave been able to achieve from a base this year?

Christopher Johns

I think that if you look at what we said today is that we’llbe in the upper half of 2007 guidance. Ithink that if you do the math on what it gets to next year, it will get yousomewhere between the 7% and 8% growth rate which I think is consistent withthe compound annual growth target of over a five-year period of time, the 8% that we’ve said.

We’ve consistently stated, you’re correct, that we have ratebase growth of around 10% in a year-over-year basis here in this next year butthat that doesn’t translate into EPS growth directly because we’ve acknowledgedsome of that is funded with more shares outstanding from equity; and in fact,we’ve issued about $120 million worth of equity this year through our 401(k)plans, our DRIP programs and stock option exercises and we’ve been veryconsistent saying that that would be one of the sources of funding that wewould use to that and I think that reconciles those items.

The news is that we’re continuing to be confident about the8%. We don’t know what the energy efficiency results will be and yet we arestill willing to say that we anticipate growing at that 8% rate. So I thinkjust so that there is clarity about it, that 8% rate doesn’t, right now,include anything around the energy efficiency because we don’t know what thatresult will be; but we do know that we have costs that are increasing on us andwe want to have the opportunity to look at whether or not we’ll need some ofthe those energy efficiency savings to offset some of those rising costs.

So we don’t want people to automatically add that andincrease the 8% growth rate above that.

Ashar Khan - SACCapital

Right. But just going back, Chris, there are no energy efficiencysavings in the next year’s forecast, is that a correct statement?

Christopher Johns

Yes. That is.

Ashar Khan - SACCapital

And then, if I’m right, you have another two years left inyour rate case plan, right? The rate case plan goes until 2009, am I right?

Christopher Johns

2010.

Ashar Khan - SACCapital

2010. So going back to my question, are the savings that youcontemplated out of your other transformational savings, are those behindschedule as we stand today?

Christopher Johns

Ashar, we haven’t commented on the details of thetransformational savings. We don’t provide those details on an interim basisand we haven’t updated the expectations around what those will be for any givenyear. As we said, some of the programs are doing better than what wasoriginally contemplated and some of them are not doing as well as originallycontemplated. We’re going through our annual review process of what those willlook like and what we’re anticipating those looking like in the future. We’llcommunicate those in the first quarter of next year.

Operator

Your next question comes from Patrick Forkin - TejasSecurity Group.

Patrick Forkin -Tejas Security Group

With respect to the SmartMetering project, you indicatedthat you should have 240,000 end points installed by the end of this year andthat you were going to continue to install the existing technology in 2008. Howmany additional end points do you think you’ll get installed in 2008?

Peter Darbee

You know, we’re not revealing those numbers at this point.Maybe in the first quarter, when we come back to talk to you, we’ll talk alittle bit more about what that deployment schedule looks like.

Patrick Forkin -Tejas Security Group

Are you evaluating the new technology for the electric metersand the gas meters?

Peter Darbee

Yes, we are. Because, again, we’re looking at acommunication network that’s closer to what we’re using on the gas meter sidetoday. So we want to be sure again that we’re consistent. We get the economiesof scale. So we are addressing both of them.

Operator

Your next question comes from Greg Gordon - Citigroup.

Greg Gordon -Citigroup

You usually give earnings guidance update in conjunctionwith the fourth quarter earnings report, which would be in late February, isthat correct?

Peter Darbee

We generally will do that when we give our fourth quarterupdate, that’s right. Our fourth quarter earnings.

Greg Gordon -Citigroup

Okay. Thank you.

Peter Darbee

Greg, I only hesitate because we haven’t scheduled when thatwould be.

Operator

Your next question comes from Michael Lapides - GoldmanSachs.

Michael Lapides -Goldman Sachs

Regarding equity issuance, can you talk about just throughyour current capital spending meaning the projects that have already beenapproved and that are outlined in various investor presentations, exactly howmuch incremental equity you expect to issue over that cycle?

Christopher Johns

We haven’t given any updates to that since the beginning ofthis year. And when we gave that in the beginning of this year, the number wasabout $750 million to $950 million. And again, we haven’t updated that. We didinfuse $200 million earlier this year of equity into the utility from theholding company and as we’ve said that we do issue equity through the stockoption programs and through our DRIP programs and through the 401(k) programsand those are things that, as I said, we’ve seen about $120 million this year.

But otherwise, we have not provided any updates on what theultimate amounts of equity over the five-year period would be since we last didthat in the first quarter of this year.

Michael Lapides -Goldman Sachs

Can you provide a high-level calendar for the filing processfor your next GRC? I know we’ve still got another year and a half or so beforewe get down in the weeds into it.

Christopher Warner

We generally would be filing what’s called a notice ofintent about a year and a half before the rate case would go into effect. Obviously,we go forward with the filing and hearings would take place over the year precedingthe effective date of the new rates and then a commission decision.

Christopher Johns

So just to be specific, Michael, so that first notice ofintent would be in the latter part of 2009. The complete filing at the very endof 2009 and then it would be litigated and decided in the 2010 timeframe forrates that would be effective January 1, 2011.

Operator

Your next question comes from Reza Hatefi - PolygonInvestments.

Reza Hatefi - PolygonInvestments

Some of the earlier questions centered around the energyefficiency and the increased O&M pressures but how do both of those relateto the transformation savings? Is there any update to forward transformationsaving opportunities?

Christopher Johns

We are not providing at this point in time any updates ontransformation savings. We’ve been pretty consistent over the last couplequarters. We’re going through a process of looking at all of our projects thatare going on right now and we’ll provide an update on those in the firstquarter of next year.

Reza Hatefi - PolygonInvestments

Is the increased cost pressure sort of eating into thepotential of the transformation savings? That is, if one was to thinktransformation savings was potentially going to be a benefit, is the newO&M putting pressure on that opportunity? Or is that not the right way tothink about it?

Peter Darbee

I think, consistent with what I said at the beginning, isthat we have to look at all of our transformation programs and evaluate whatthe cost pressures are on each one of those and look at what we believe theirsuccess will be. We’ll provide an update in the first quarter on that.

Operator

There appear to be no further questions from the phones.

Gabriel Togneri

All right. In that case, I would like to thank everybody foryour interest today and I’m sure we’ll see many of you at the EEI conference onMonday and Tuesday. Thank you.

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