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Avista Corporation (NYSE:AVA)

Q2 2012 Earnings Call

August 7, 2012 10:30 am ET

Executives

Jason Lang - Manager, IR

Scott Morris - Chairman, President and CEO

Mark Thies - SVP and CFO

Dennis Vermillion - SVP and President, Avista Utilities

Kelly Norwood - VP, State and Federal Regulation

Analysts

Michael Klein - Sidoti & Company

Paul Ridzon - KeyBanc

Brian Russo - Ladenburg Thalmann

Eric McCarthy - Praesidis Advisors

Chris Ellinghaus - Williams Capital

James Bellessa - D.A. Davidson

Operator

Good day, ladies and gentlemen, and welcome to the Avista Corporation second quarter 2012 earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today's call, Mr. Jason Lang, Investor Relations' Manager.

Jason Lang

Good morning, everyone. Welcome to Avista's second quarter 2012 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's Chairman of the Board, President and CEO, Scott Morris; Senior Vice President and CFO, Mark Thies; Senior Vice President and President of Avista Utilities, Dennis Vermillion; Vice President of State and Federal Regulation, Kelly Norwood.

I would like to remind everyone that some of the statements that will be made today are forward-looking statements that involve assumptions, 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, please refer to our Form 10-K for 2011 and our Form 10-Q for the first quarter of 2012, which are available on our website.

To begin this presentation, I'd like to recap the financial results presented in today's press release. Our consolidated earnings were $0.31 per diluted share for the second quarter of 2012 compared to $0.39 for the second quarter of 2011. On a year-to-date basis our consolidated earnings were $0.96 per diluted share for 2012 compared to $1.12 for 2011.

Now, I'll turn the discussion over to Scott Morris.

Scott Morris

Thank you, Jason, and good morning, everyone. Avista's earnings for the second quarter and first half of 2012 were below our expectations largely because retail loads were lower than we anticipated. The continued weak economy and operational challenges at certain industrial customers resulted in lower retail sales volumes. Based on results for the first half of the year and a reduction in our forecasted loads for the remainder of 2012, we expect our consolidated and utility earnings to be at the lower end of our guidance range for the year.

This spring we had above average precipitation and streamflows, which resulted in strong hydroelectric generation in the second quarter and first half of 2012. In addition, purchased power and natural gas fuel prices are below the level included in base rates, which ultimately benefits both customers and shareholders. We continually strive to reduce cost and improve efficiency and productivity in our utility business.

The net decrease and other operating expenses was driven by decreased electric maintenance cost, which included the regulatory deferral of certain maintenance cost and reduced outside services, partially offset by increased expenses for pension and post-retirement benefit.

Results from Ecova, our primary unregulated subsidiary, improved in the second quarter of 2012 as compared to the first quarter of 2012. The costs of completing the acquisitions of Prenova in November 2011 and LPB Energy Management in January of 2012, and the accelerated pace of integrating the companies in the first quarter resulted in a decrease in earnings for the first half of 2012 as compared to 2011.

The acquisitions increased Ecova's market share and allow Ecova to offer its clients a broader range of services leading to potential future earnings growth. Ecova's revenues continue to grow as it expands its customer base. We expect the business to have strong results in the second half of the year.

To maintain service reliability and meet the energy needs of our customers, we expect to continue to make significant capital investments in generation, transmission and distribution systems. Utility CapEx was $120 million for the first half of 2012 and have a capital budget of $257 million for 2012. We also expect utility CapEx to be about $250 million in each 2013 and 2014.

We regularly review the need for rate changes in each jurisdiction to improve the recovery of operating cost from capital investment and to provide the opportunity to improve our earned returns as allowed by regulators. As you'll recall, we filed electric and natural gas general rate cases in Washington in early April, and we're planning to file general rate cases in Idaho in the second half of 2012.

We tracked three key economic indicators effecting three distinct metropolitan areas in our service area, Spokane, Coeur d'Alene, Idaho and Medford, Oregon. The key indicators are employment change, unemployment rates and foreclosure rate. We have observed mixed results during the economic recovery.

The June 2012 employment indicators are positive except for Spokane. We noted that unemployment rates are lower in all three areas, and foreclosure rates have decreased compared to prior period.

Our service area economy has been recovering more slowly than the U.S. as a whole. In 2012 we continue to expect economic growth in our service area to be lower as compared to United States. And although, the economy and lower than expected loads have hurt our 2012 results, we continue to be well-positioned for the future.

Now, I'd like to turn this presentation over to Mark.

Mark Thies

Thanks, Scott. Good morning, everyone. For the second quarter of 2012, utility earnings contributed $0.31 per diluted share, which is a decrease from $0.36 in the second quarter of last year. On a year-to-date basis, utility earnings contributed $0.97 per diluted share, a decrease from $1.06 last year.

The decrease in quarterly and year-to-date earnings was primarily due to decrease in gross margin and partially due to expected increases in depreciation, amortization and interest expense.

The decrease in gross margin was primarily due to warmer weather. It was also due in part to the continued economy and lower energy usage at certain industrial customers, which we expect to be temporary that reduced retail loads. These decreases and energy usage were partially offset by general rate increases and a decrease in operating cost.

Heating degree days in Spokane were close to historical average for 2012, but were 21% lower than the second quarter of 2011, and 9% lower than the first half of 2011. For the second quarter of 2012, we recognized a benefit of $1 million under the energy recovery mechanism compared to an expense of $0.2 million for the second quarter of 2011.

For the six months ended June 2012, we recognized a benefit of $5.1 million under the energy recovery mechanism compared to $4.7 million in the six months of June last year. We expect the benefit under the ERM for the full year of 2012 to be within the 90% customer, 10% company sharing band. This is primarily due to natural gas fuel prices below the amount included in base rates, and as Scott mentioned, the above normal hydroelectric generation.

Ecova's year-to-date revenues increased $18.1 million as compared to the first half of 2011 and totaled $77.1 million. The acquisitions of Prenova and LPB added $11.6 million to operating revenues for the first half of 2012. Although revenue growth was lower than we expected for the first half of the year, we expect to see growth in the second half of the year, similar to the organic growth rate that we reported in 2011.

The $25 million increase in total operating expenses for Ecova, reflects primarily the increased cost necessary to drive and support ongoing and future business growth as well as to support the increased revenue volume obtained through the acquisitions. In addition, Ecova incurred $1.5 million in transaction and integration related cost.

Depreciation and amortization increased $2.9 million for the first half of 2012, due to intangibles and other long live assets recorded in connection with the acquisitions. Ecova's $60 million committed line of credit was fully utilized as of June 30. In July, Ecova entered into a new five year $125 million committed line of credit with various financial institutions, replacing its $60 million committer line of credit.

The previous owners of Cadence Network, a company acquired by Ecova in 2008 had a right to have their shares of Ecova common stock redeemed by Ecova during July of 2011 or July of 2012. These redemption rights were not exercised and expired effective July 31, 2012.

The net loss from our other businesses was $1 million for the second quarter and $1.3 million for the first half of 2012. The decline in results from 2011 was primarily due to increased litigation costs for the remaining contracts and previous operation of Avista Energy as well as a net loss on investments.

Earnings from METALfx were $0.8 million for each of the six months ended June 30, 2012 and 2011. Losses on venture fund investments were $0.5 million for the six months ended June 30, 2012 compared to less than $0.1 million in 2011.

As of June 30, we had $284 million of available liquidity under our $400 million committed line of credit, with $91 million of borrowings and $25 million in letters of credit outstanding.

In June 2012, we entered into a bond purchase agreement with certain institutional investors in the private placement market for the purpose of issuing $80 million of 4.23% First Mortgage Bonds due in 2047. The issuance of the bonds will occur at closing in November of 2012.

In connection with the pricing of the bonds, we cash settled interest rate swap contracts with a notional amount of $75 million and paid a total of $18.5 million. Upon settlement of the interest rate swaps, the regulatory asset or liability is amortized as a component of interest expense over the life of the forecasted interest payments.

We expect to issue up to $45 million of common stock in 2012 in order to maintain a prudent capital structure. We issued $3.6 million in the first half of the year. The additional shares are expected to be issued under a periodic offering program as well as the dividend reinvestment and direct stock purchase plan and employee plan.

Now, I'd like to talk a little bit about guidance. We expect our 2012 consolidated earnings to be at the lower end of our guidance range of $1.65 to $1.85 per diluted share. We experience lower than expected retail loads during the first half of 2012, and we reduced our forecasted loads for the reminder of the year. We estimate that the reduction in our loads from our original expectations will reduce our 2012 earnings per share by approximately $0.10 to $0.12.

We expect Avista Utilities to contribute at the lower end of the range of $1.51 to $1.66 per diluted share for 2012, which includes a benefit under the ERM in 2012 within the 90% customer, 10% company sharing band. It is important to note that the forecast of our position in the energy recovery mechanism can vary significantly due to a variety of factors, including the level of hydroelectric generation and retail loads as well as changes in purchased power and natural gas fuel prices.

Our outlook for Avista Utilities assumes among other variables normal precipitation and temperatures for the remainder of 2012. We continue to expect Ecova to contribute in the range of $0.16 to $0.19 per diluted share for 2012, and the other businesses to be between a breakeven and a loss of $0.02 per diluted share.

Now, I'll turn the call back over to Jason.

Jason Lang

Thank, Mark. And now, we'll open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question comes from the line of Michael Klein with Sidoti & Company.

Michael Klein - Sidoti & Company

Just on the guidance, what gives you confidence, you didn't hit your guidance range at Ecova. I mean it implies a pretty significant jump in the back half?

Mark Thies

You're correct. We made $0.01 per share in our guidance to $0.16 to $0.19. A lot of that has to do with the timing of the revenues that certain of their programs tend to be later in the year. And we do expect to have more significant revenue growth in the second half of the year as compared to the first half of the year. And we believe we'll be able to be in our guidance range.

Michael Klein - Sidoti & Company

And in terms of costs at Ecova, are those expected to wind down in the back half of the year as well or is the earnings guidance driven mainly by revenue?

Mark Thies

The guidance is primarily driven by revenue. The cost we did incur in the first quarter and acceleration of certain integration costs. But we continue to work with that integration. It's not completed as of the first quarter. But we had an acceleration of cost, so we expect some cost to continue to be incurred, but is largely driven more by revenue growth in the second half of the year.

Michael Klein - Sidoti & Company

I guess, given the cost and the revenue ramp right now that we're expecting. When do you expect to hit a normalized run rate? Do you think we'll exit 2012 kind of on a run rate that we can expect as a harbinger for future growth going forward or is that still a little early?

Mark Thies

I think, when we get through 2012, again the acquisitions occurred in November of last year as well as January of this year, so we'll have almost a complete year for both of those acquisitions. So by the end of the year, we should have a pretty good sense of what our revenues are, and then we would expect to continue to have organic revenue growth, because of the position we have.

We think there is a lot of runway left to continue to grow our business organically as well as we will continue to look for potential acquisitions if they fit and add to our businesses we have today. And we've done that for the past several years.

Michael Klein - Sidoti & Company

And last question, switching over to the utility. You said some operational challenges at industrial customers. Does that imply that there maybe a one-time event, is it more temporary or is this maybe something of a more permanent nature?

Scott Morris

Mike, just for example, we had a large silver mine in North Idaho that had to close down for some safety reasons, but are starting to ramp up again and have been cleared. So we expect to have work come back. So that's a great example.

We currently have a large paper manufacturer that's had some machine problems and motor problems. They're fixing that and it will take some time for them to get new equipment. So, yes, the industrial loads on those two examples are temporary.

Operator

And our next question comes from the line of Paul Ridzon with KeyBanc.

Paul Ridzon - KeyBanc

Are those two customers kind of the biggest drag?

Mark Thies

The biggest drag for the results, no. They are a portion of the drag. The overall economy is probably the biggest drag. Overall, our results across commercial and industrial loads were more than those customers. Those customers probably represented, I don't know, 20% to 30% of our drag.

I mean that's a meaningful number, but it's not the majority. The majority is the overall economy is slower than what our expectations were. And we have seen the results in the first half and we also changed our forecast to look forward, and say, we expect that to continue. It's just not recovering this fast.

Paul Ridzon - KeyBanc

And then, secondly in the commentary about the utility, you said that operating cost were down. When I look at the consolidated income statement other operating costs seem to be up. Is that all that Ecova's at?

Mark Thies

Yes, that would be the difference. And again, that's largely due to some growth and operating cost to prepare for the additional revenue and the acquisitions that we did last year and beginning of this year.

Paul Ridzon - KeyBanc

How much of that is in acceleration of cost as opposed to what we expect to be a normal run rate?

Mark Thies

Well, what we said was that the transactional cost was $1.5 million in the first quarter related to that. And that's the only number that we've given out. The rest are just part of cost, as part of their business.

Paul Ridzon - KeyBanc

But that the goodwill amortization shows up in depreciation, correct?

Mark Thies

Correct. And yes, it does.

Operator

And our next question comes from the line of Brian Russo with Ladenburg Thalmann.

Brian Russo - Ladenburg Thalmann

Could you breakdown the EPS variance between weather and the slowdown or operational issues in industrial sales or equity economy?

Mark Thies

What we've said is really from a year-over-year perspective, we are down about 9% from weather from a degree day perspective, but really it was close to normal. On our forecast, we try to include normal. Most of our issue for the year, and going forward, for the outlook for guidance is related to the economy and the operational challenges that we had at the certain customers, as Scott described.

So we said actually specifically in our guidance, $0.10 to $0.12 is what that impact is. That includes six-months to date and our forecasted expectation of continued weakness.

Brian Russo - Ladenburg Thalmann

Could you update us on what your updated load forecast is for the rest of the year?

Mark Thies

It's about half of what that expectation is, little less than half of that expectation, that we incurred already.

Brian Russo - Ladenburg Thalmann

And can you remind us the changes in your load forecast. Can that be captured in this pending Washington rate case, and thus won't contribute to any sort of under recovery or lag, when do rates go into effects in early 2013?

Kelly Norwood

In our original filing, we included you probably had seen an attrition adjustment. Part of that attrition adjustment is to reflect the expected loads during that future rate year, which is 2013.

Since we have recently revised our load forecast, we actually did modify our attrition adjustment, and we've provided that information to all parties. Though, I will say there is opportunity to reflect it. There is no guarantee, but certainly, before all the parties and we will certainly next year that it's viewed by the Commission and considered as part of the end result.

Brian Russo - Ladenburg Thalmann

So part of the attrition adjustment reflects the load forecast in '13, as well as the post test year debt plan additions?

Scott Morris

That's correct. And essentially what you're doing with an attrition adjustment is taking a look at your growth in net plant investments or rate base, your growth in your expenses, and then compare that to your growth in loads. And if your growths in loads are lower, you'll have a higher attrition adjustment.

Brian Russo - Ladenburg Thalmann

This is a one-time only-event. You don't have to re-file in your next rate case to keep this ongoing or is it something that could be permanent?

Mark Thies

It could be permanent, but our proposal at this point is to address it in this case, we would need to propose it again in the next case.

Brian Russo - Ladenburg Thalmann

And the historical test year and the regulatory lag attributable to that, that's currently about 60 basis points to 80 basis points?

Scott Morris

Yes, within that neighborhood 60 to 80, 70 to 90's somewhere in that neighborhood.

Brian Russo - Ladenburg Thalmann

And if you're precedent for this, or maybe you can put it into context as to how staff or the Commission might view this, maybe, just add some color to that?

Scott Morris

We actually had attrition adjustment for our company back in the 80s. And in fact a Washington Commission policy statement came out in December of 2010, the Commission had noted that an attrition adjustment maybe appropriate to consider.

And then the Washington staff in their testimony indicate, also suggested that an attrition adjustment maybe the solution to addressing the lag issue. So that's what in front of us now, and we're hopeful that commission will approve in the form of attrition adjustment.

Brian Russo - Ladenburg Thalmann

And we're still awaiting staff in your general rate case, correct?

Scott Morris

That's correct. Their testimony is due, September 19.

Brian Russo - Ladenburg Thalmann

And just moving or changing gears to Ecova. Remind us of the current appraisal value, I think in the March 10-Q, the appraisal value of the 20.8% minority interest was $44.3 million. I suppose that might be higher, with some of the recent acquisitions, if you would have reappraised it, and does that reappraised quarterly?

Scott Morris

We do put in and this will actually be the last quarter that we do that, is in our 10-Q which we'll file today will have a listing of what it was, as of June 30. But then after that that put right goes away, as we talked about the redemption rights expired on exercise, so we won't see that. The acquisitions, though, typically from a purchase price versus a value creation, they wait a year to determine what that impact was. So we don't expect to see that until next year.

Kelly Norwood

And Brian, I would just add that, while I can speak for our minority partner, I think its a great indicator of our minority partner's confidence in this business that they have not exercised their put right, and feel optimistic about the future. We think that that the company really has an opportunity to continue to grow.

And while there is a hockey stick with the revenues in the second half of the year, I would like to remind people that when we do book new clients, bookings have been strong and that is does take a month or two or three often to get those clients kind of situated in online and into the systems.

So once we sign somebody, there is a little bit of lag from the signing into actually driving revenues. So that's why the second half of the year is going to be stronger than the first half of the year.

Brian Russo - Ladenburg Thalmann

And in terms of the long-term strategic plan, you mentioned in the Qs and the Ks, you might look to monetize it or take it public. Just wondering, you guys have bolted on quiet a number of acquisitions. You're going to be well in north of $100 million in sales. Just want to get a sense for what the long-term strategy is for Ecova?

Scot Morris

Brian, we still are so confident about this business. We continue to see significant upside to this business. We continue to add more products, more services. There is more demand for the product.

And we're getting to see opportunities not just in the commercial industrial side, but our utility business is quiet strong. Given all of that, we're going to continue to invest in the business, we're going to continue to drive organic growth, as Mark mentioned.

And really any kind of monetization strategy is going to be, if we do want, it's going to be timed and we can maximize shareholder values. So I really can't give you a timeframe, what I'm telling you is that because we see the runway, and because we see some good upside, we're going to continue to do everything we can do to support that business to maximize shareholder value. The timing really becomes, in our opinion secondary to making sure that we keep this business viable and growing.

Operator

And our next question comes from the line of Eric McCarthy with Praesidis Advisors.

Eric McCarthy - Praesidis Advisors

My question was asked, anyway, thank you.

Operator

And our next question comes from the line of Chris Ellinghaus with Williams Capital.

Chris Ellinghaus - Williams Capital

Mark, can you give us any more color on the seasonality that you're expecting out of Ecova going forward?

Mark Thies

I don't know if there is much seasonality, as there is couple of things. We added the few companies, and we're integrating those companies, and then trying to grow organically, as we added new clients. So part of that, as Scott said, we continue to have additional bookings and we continue to see strength there, but it takes some time to get back to revenue growth.

And then there are some in certain of the programs in the utility space, that half portion of the business, is tend to ramp up historically over the second half of the year and largely a lot of it even occurs in the fourth quarter. So we expect to see that again. We continue to see strength in that business. And historically, we've seen the growth in the fourth quarter and we continue to expect that.

Chris Ellinghaus - Williams Capital

Can you quantify at all, what your offline industrial customers meant in first and second quarter?

Mark Thies

Well, what I indicated was in our $0.10 to $0.12 it was about 20% to 30% of that. That's our expectation. That's as close of a quantification, as I'm comfortable.

Chris Ellinghaus - Williams Capital

And I'm sorry, I miss this. But would you say about the ERM for the second quarter?

Mark Thies

It was to $1 million, I believe

Chris Ellinghaus - Williams Capital

And where did that put you to, for the year-to-date?

Mark Thies

$5.7 million.

Operator

And our next question comes from the line of James Bellessa with D.A. Davidson.

James Bellessa - D.A. Davidson

When you set your 2012 EPS guidance range of $1.65 to $1.85, you assume some type of load, and now you're saying that that load for 2012 was lower than you had planned, and you're saying that the earnings drag from the lower load is $0.10 to $0.12. How much of that was the first half of the $0.10 to $0.12, how much is for the first half?

Mark Thies

Jim, what I said before it was just a little less than half.

Operator

Ladies and gentlemen, we've no further questions. This concludes today's questions-and-answer session. I would now like to turn the call back to Mr. Jason Lang for closing remarks.

Jason Lang

I want to thank everyone for joining us today. We certainly appreciate your interest in our company. Have a great day.

Operator

Ladies and gentlemen, we thank you for your participation in today's conference. This concludes the presentation. And you may now disconnect. Have a good day.

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