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Avista Corp. (NYSE:AVA)

Q2 2008 Earnings Call

July 30, 2008 10:30 am ET

Executives

Jason Lang - IR Manager

Scott Morris - Chairman, President and CEO

Malyn Malquist - EVP and CFO

Kelly Norwood - VP, State and Federal Regulation

Analysts

Brian Russo - Ladenburg

Paul Ridzon - KeyBanc

Ifran Doza - Romantic Management

Eric Beaumont - Copia Capital

David Thickens - Deephaven

Paul Patterson - Glenrock Associates

James Bellessa - D.A. Davidson & Co.

Steve Gambuzza - Longbow Capital

Operator

Good day, and welcome to the Second Quarter 2008 Avista Corporation’s Earnings Call. My name is Candace, and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of today’s conference. (Operator Instructions). It’s my pleasure to introduce your host for today’s conference, Manager of Investor Relations, Mr. Jason Lang. Sir, you may proceed.

Jason Lang

Thank you, Candace. Good morning, everyone. Welcome to Avista’s second quarter 2008 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; Executive Vice President and CFO, Malyn Malquist; Vice President of Finance and Treasurer, Ann Wilson; Vice President State and Federal Regulation, Kelly Norwood and Vice President and Controller and Principal Accounting Officer, Christy Burmeister-Smith.

Before we begin, I’d like to remind you that some of the statements that will be made today are forward-looking statements that involve risks and uncertainties, which are subject to change. For reference to the various factors which could cause actual results to differ materially from those discussed in today’s call, I would direct you to our Form 10-K for 2007 and Form 10-Q for the quarter ended March 31, 2008 which are available on our website.

To begin this presentation, I would like to briefly recap the financial results presented in today’s press release. Our consolidated results for the second quarter of 2008 were net income of $0.44 per diluted share, compared with earnings of $0.26 per diluted share for the second quarter of 2007. On a year-to-date basis of our earnings were $0.91 per diluted share, compared to $0.53 per diluted share for the first half of 2007.

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

Scott Morris

Well. Thank you, Jason, and good morning, everybody. Overall, we’re very pleased with our results for the second quarter and first half of 2008. Results for the first half of 2008 have positioned us well to me our earnings targets for the year. The general rate increase in Washington implemented at the beginning of 2008 was the primary reason for the improvement on our utility results. In addition to the improvement at utility, our consolidated results increased as compared to 2007 due to the net loss in Avista Energy in the prior year.

Unusual weather patterns resulted in both higher-than-expected resource costs and increased retail loads. The slight shortfall in earnings relative to our expectation for the second quarter and first half of 2008 was largely due to a higher-than-expected electric resource cost. We absorbed $4 million of cost in the second quarter of 2008 and $7.4 million for the first half of 2008 under the energy recovery mechanism at Washington. This was primarily due to colder-than-normal weather and later-than-expected runoff and while we had good snow pack conditions, the temperatures remained cool so that runoff through mid-May was well below normal.

In addition to below-normal hydroelectric generation, fuel and purchased power costs were higher-than-expected to meet increased demand. And although we had above normal hydro generation from mid-May through July, it will most likely not be enough to make up the entire shortfall from earlier in the year. However, we should recover a portion of the $7.4 million of cost absorbed during the first half of the year under the ERM, primarily due to above normal hydro generation for July.

Actual hydroelectric generation will depend upon precipitation, temperatures and other variables during reminder of the year. It’s important to note that the amounts recognized under the ERM can vary significantly from quarter-to-quarter due to a variety of factors including the level of hydroelectric generation, as well as changes in purchase power and fuel cost.

Partially offsetting the negative effect of higher electric resource costs was higher-than-expected retail natural gas loads due to colder than normal weather. We filed request for increases in electric and natural gas general rates in Washington in March 2008 and in Idaho in April 2008. The filings are designed to recover increases in fuel and purchase power costs to meet growing customer demand, infrastructure investments to increase capacity and reliability, the licensing cost for our Spokane River Hydroelectric Project, and expanding the storage and delivery capacity at the Jackson Prairie Natural Gas Storage Project.

Our request in Washington is for base rate increases averaging 10.3% for electric and 3.3% for natural gas. Combined, this is designed to increase annual revenues by $43.2 million. This request is based on a proposed rate of return of 8.43% with a common equity ratio of 46.3% and a 10.8% return on equity.

On Monday, we filed an update to our demonstrated need for electric rate relief in Washington, primarily to reflect an increase in natural gas fuel cost. And although the update justifies an electric revenue requirement of $47.4 million compared to our original request of $36.6 million, we are not revising our original revenue increase request.

Our request in Idaho is for the base rate increases averaging 16.7% for electric and 5.8% for natural gas. And I would like to note that this is our first request to increase base rates in Idaho since 2004. Combined, this is designed to increase annual revenues by $37 million. This request is based on a proposed rate of return of 8.74% with a common equity ratio of 47.9% and a 10.8% return on equity.

On Monday of this week the Idaho Commission staff advised the Idaho Commission by a letter that it had essentially completed its audit and discovery related to our electric and natural gas general rate cases, and intends to engage in settlement negotiations. We are hopeful that the settlement discussions will be successful. The original procedural schedule established by the Idaho Commission provides for an order by November 2008. Any rate adjustments, if approved by the Washington or Idaho Commissions, would most likely become effective in late 2008 or early 2009.

We are becoming increasingly concerned about the price of natural gas and the impact on our customers’ energy bills. And although prices have decreased in the past couple of weeks, we’re still expecting an increase in natural gas rates for purchased gas adjustments to be implemented in the fourth quarter of 2008. Purchased gas adjustments are designed to pass through changes in natural gas costs to our customers with no change in gross margin or net income. We continue to make and plan for significant capital investments in our utility.

For the first half of 2008, our capital expenditures were approximately $90 million. For the full-year of 2008, our capital budget is approximately $200 million and we are expecting our capital budgets to exceed $200 million in 2009 and 2010. We’re planning to update certain hydro projects, and we will continue to enhance our natural gas and electric distribution system.

In the second quarter of 2008, we completed the acquisition of the wind-generation site. We expect to construct a 50-megawatt generation facility at a total estimated cost of over $125 million to be completed in 2011. In June 2008, we filed petitions with the Washington and Idaho Commissions requesting that costs, including land, turbine down payments and other preliminary costs associated with the project be accounted for as construction work-in-progress. This would allow us for the accrual of AFUDC, and I’m pleased to report that the Idaho Commission approved our request on Monday. It is possible that we may need to make a down payment on wind turbines before the end of 2008. This is not included on our estimated capital expenditures.

And finally, we are very pleased about Advantage IQ’s acquisition of Cadence Network, effective at the beginning of the third quarter of 2008. We believe that combining the resources and expertise that Cadence has developed with those at Advantage IQ will give us the ability to leverage growth in our subsidiary and drive additional values for its clients and our investors.

And now, I will turn this presentation over to Malyn Malquist for an update on the financial results for each segment of our business, plans for Advantage IQ, our financing activities, and our earnings guidance.

Malyn Malquist

Well, thanks, Scott, and good morning, everyone. Avista Utilities contributed $0.41 per diluted share for the second quarter of 2008, compared with $0.32 per diluted share for the second quarter of last year. On a year-to-date basis, our Utility operations contributed $0.85 per diluted share, an increase from $0.70 per diluted share in 2007.

As Scott mentioned, the improvement in results was primarily due to the Washington general rate case implementation. The positive effects of the general rate case increase were partially offset by expected increases in other operating expenses, depreciation and amortization and taxes other than income taxes. For the second quarter, interest expense was higher than originally expected due to the timing of our debt issuance.

In April of 2008, we issued $250 million of 5.95% First Mortgage Bonds to refinance $273 million of 9.75% senior notes, which matured on June 1, 2008. Although this will provide significant cost savings going forward, both issuances were outstanding during April and May. Due to the uncertainty and some lack of liquidity in the financial markets, we decided to issue these bonds earlier than we were planning, taking some risk off the table. In retrospect, we are very pleased with the 5.95% interest rate.

Turning to Advantage IQ, the company’s net income for the second quarter and first half of 2008 was slightly higher than the comparable periods of 2007, due to an increase in operating revenues as a result of customer growth, partially offset by a decrease in interest revenue on funds held for customers and increased operating costs. On a year-to-date basis, total revenues increased to 11% from service revenues, which increased 22%, partially offset by a 32% decrease in interest revenue.

As a consideration for the acquisition transaction, the previous owners of Cadence Network received a 25% interest in Advantage IQ. While we anticipate an increase in annual revenue as a result of the acquisition, the transaction is expected to be slightly dilutive to our consolidated earnings in 2008 by 0.01 to $0.02 per share due to transaction costs and the decrease in our ownership of the subsidiary.

We believe the acquisition of Cadence will significantly enhance the long-term value of Advantage IQ, which was already a very attractive business. While we considered Cadence a major competitor, their products and service offerings are also very complementary to Advantage IQs. Advantage IQ will be able to offer its customers and the Cadence customers a more complete attractive package than either company could do on a stand-alone basis.

For example, Advantage IQ offers telecom service, which Cadence does not offer. However, Cadence offers a more robust consulting service than Advantage IQ. Both companies have experienced very rapid growth with Cadence revenue growing over 40% last year. Integration activities are well underway. We are planning to monetize at least a portion of our investment in Advantage IQ during the next two to four years. The potential modification could be completed through an initial public offering or a sale of the business depending on future market conditions, growth of the business and other factors.

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

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

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

During the first half of 2008, positive cash flows from operating activities were used to fund the majority of our cash requirements excluding debt maturities. These cash requirements included utility capital expenditures of approximately $90 million, dividends of $17.6 million and the cash settlement of interest rates swaps of $16 million. We are currently planning to issue additional long-term debt during the second half of 2008 to fund other maturing debt, as well as to provide additional funding for capital expenditures and other corporate purposes.

We have a sales agency agreement issue up to two million shares of common stock from time to time. We’re planning to begin issuing common stock under this sales agency agreement during the second half of 2008. This should help us maintain our equity ratio in an appropriate level. The issuance of common stock should also help us to maintain or improve upon certain financial metrics necessary to maintain or improve our credit ratings. Our 2008 earnings guidance assumes the issuance of common stock.

As we have indicated in past calls, management intends to recommend that the Board consider gradually increasing the dividend payout ratios to become more in line with the average payout ratio for the utility industry, which is currently approximately 60 to 70% of earnings.

As you will recall, the Board raised the quarterly dividend by 10% from $0.15 to $0.165 per share in February. Management intends to recommend that the Board further review our dividend level during the second half of 2008. The Board considers the level of dividends on a regular basis taking into account numerous factors including financial results, business strategies and economic and competitive conditions. The declaration of dividends is within the sole discretion of the Board.

We are confirming guidance for 2008, consolidated earnings to be in the range of $1.35 to $1.55 per diluted share. The company expects Avista Utilities to contribute in the range of $1.20 to $1.40 per diluted share for 2008. The outlook for the utility assumes among other variables normal precipitation temperatures and hydroelectric generation for the remainder of the year.

We are confirming our guidance for Advantage IQ in the range of 0.10 to $0.12 per diluted share. We expect the other businesses to be close to break-even for the year. However, we are not changing our guidance of between break-even and a loss of $0.03 per diluted share at this time.

And now, we would like to open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question will come from the line of Brian Russo of Ladenburg. Please proceed.

Brian Russo - Ladenburg

Hi, good morning, guys.

Scott Morris

Hi, Brian.

Malyn Malquist

Good morning, Brian.

Brian Russo - Ladenburg

Just curious, I got on the call just a little bit late. I think you said that, July hydro conditions, will that be enough to offset the total impact of the ERM in the first half of the year or not?

Scott Morris

No, it will not, Brian.

Brian Russo - Ladenburg

It will fall short?

Scott Morris

It will fall short. We are really pleased with the July hydro results, but it is not quite enough to make up for the poor conditions we suffered in, primarily April of this year.

Brian Russo - Ladenburg

Okay. And so that, I guess, would imply, say, the middle of your guidance range is assuming normal hydro. And then your ability to reach the high-end of your range would be really dependent on weather?

Malyn Malquist

Brian, this is Malyn. I think that there are still a lot of variables that can impact us. We assume normal hydro through the rest of the year, if we had a very wet fourth quarter, which we had two years ago that would be very helpful to us and probably puts us back into the high-end of the range. We are working real hard to do our best to be somewhere in the middle there, if you will. But there is a lot of variables that happened between now and the end of the year. July is going to be very helpful, but we still are going to absorb some expenses under the ERM, and we know that and we are working to offset those in other areas.

Brian Russo - Ladenburg

Okay. And in terms of the debt issuances you plan in the second half of ‘08. Can we -- is it going to be First Mortgage Bonds with similar rates as the recently issued debt?

Scott Morris

Brian, we’ll be First Mortgage Bonds, rates have moved up and so if we were to issue today they wouldn’t be a bit higher, depending on the maturity that we select and we haven’t selected that yet. But I would expect that some time between September and December, you will see us in the market for probably around $100 million of First Mortgage Bonds; tenured to be, yet determined, as well as interest rate.

Brian Russo - Ladenburg

Okay. And just lastly, can you quantify the down payment on the wind turbines?

Malyn Malquist

At this point, Brian, it is really hard to estimate what that number is going to be. We know that total price is going to be well over $125 million, we know that the price of the turbines will be 50 to 75% of the total cost of projects, so it really depends on that and usually they ask for anywhere from a 10 to 20% down payment. So --

Brian Russo - Ladenburg

Okay. Thank you very much.

Operator

Our next question will come from the line of Paul Ridzon of KeyBanc.

Paul Ridzon - KeyBanc

Good morning, how are you?

Scott Morris

Hi, Paul. Great.

Malyn Malquist

Hi, Paul.

Paul Ridzon - KeyBanc

What was the cost of the land, in terms of the wind farm?

Malyn Malquist

Paul, we expect $2 million to date on land acquisitions, and a majority of the cost really will be in leases for the property. So the land cost will not be a major expense for the wind turbines, again the majority of the cost is really going to be the price of the turbines itself, the construction, building the roads into the property, getting -- making sure that you have got all of the different easements that you need to have and any adjustments that we need to make to -- things that are out in the property themselves like other radio towers, cell phone towers and do we need to move some of that to make sure that we can get all of the generation we can out of the wind, so that is really where the majority of the cost will come.

Scott Morris

There was quite a bit of work done on the front end, Paul, by another party to qualify the site and look at the wind potential that was there, and that really is what we have acquired at this point, is all of the work that they have done.

Malyn Malquist

And it has been fully permitted. So, we are ready to go.

Paul Ridzon - KeyBanc

And, Malyn, I think you indicated, when you talked, the other segment would be about break-even, although formal guidance is break-even to a loss of $0.05. What’s driving that improvement?

Malyn Malquist

We have really worked -- it is zero to three, Paul, was the guidance. We have really, I think, worked to cleanup the cats and dogs that were out there, we have one really remaining operating business besides the Avista Energy, which has some payments in and out associated with kind of the maintenance of that business. But the company METALfx, which was acquired as one of the Pentzer acquisitions back in the 90s, we have been working to get that business profitable and indeed it has been profitable for over 12 months in a row, and we’re hopeful in the next year or so being able to sell it.

So the improvement there, as well as a kind of disposing off some other assets that we have had, the venture funds that we invested in, again, a number of years ago that are legacy investments actually, couple of them made money this year and one of them, I think, lost a little bit. But I am really pleased that we are at the point where we are pretty much at break-even in that business. And I don’t see much variability there on a going-forward basis, which I think is very positive.

Paul Ridzon - KeyBanc

And in the second quarter, IQ showed incremental growth. Is that -- did you incur any transaction costs in the second quarter?

Scott Morris

We are booking all the transaction costs in July and the third quarter. So that’s when you will see that. Really the only negative we’ve seen in that business is the lower float revenue that we have been getting, which has been significant. And so the fact that we are still seeing an increase in net income, I think is very positive. And we think that there is some good potential upside there on the float, because if we start of see the Fed raising interest rates that could be very helpful for this business.

Paul Ridzon - KeyBanc

And what was the tenure on the 5.95?

Scott Morris

10 years.

Paul Ridzon - KeyBanc

Okay. I missed how much that was?

Scott Morris

250 million.

Paul Ridzon - KeyBanc

Okay. Thank you very much.

Scott Morris

Okay.

Operator

Our next question will come from the line of [Ifran Doza of Romantic Management). Please proceed.

Ifran Doza - Romantic Management

Good morning, guys.

Scott Morris

Good morning.

Malyn Malquist

Good morning.

Ifran Doza - Romantic Management

Just had a couple of questions on the hydro situation. Can you guys give us a sense in terms of magnitude, like how much can you true up from the negative side in the next six months? Meaning, are you going to be, as you look through the next six months and given that we already have July in the books almost, I mean, are you going to be slightly negative, meaningfully negative. Can you give -- help us with certain level of magnitude?

Scott Morris

Yeah. I will try to do that, because I think that is -- it is important obviously to your forecast. If you think about where we are in the ERM, we’re into the 90/10 sharing at this point. And so before we get any benefit, we have got -- we are at about 14, $15 million to the negative. And so we’ve got to make up 5 or $6 million, which would flow back 90% to our customer balance before we start a see any bottom line impact.

I do believe that we are going to be somewhere between that zero and the high-end of the 50/50 sharing, probably close to -- somewhere close to the mid-point in there. But that could change so much based on, if you are really close to the 100% level, if you get $1 million of benefit through more hydro that outflows the bottom line. So we don’t see -- we see very little downside, because we are in the 90/10 sharing, but we see actually quite a bit of potential upside, because we could get back into the debt band of 50-50 and may be even into the dollar for dollar range.

So, where do I think we’re going to end up? Right now, best guess is, we’re going to be somewhere between zero and the 90/10 probably close to the middle point. But -and that’s based on a very good July that we know we are having, but then we’ve got five more months to go. And under normal circumstances, normal hydro, normal weather conditions I think we are going to be around at middle of that zero to $10 million of excess cost, which puts us in the middle of 50/50 sharing if you will.

Malyn Malquist

I would just add to that fact that natural gas prices have come down in the last three or four weeks also is a good sign for us to get into that middle range.

Ifran Doza - Romantic Management

So we should be thinking about between zero and the negative five. I mean, if you look at the numbers, you are already -- I think the first 7 million is plus or minus shareholders or you’re looking at between zero to negative five for the whole year?

Scott Morris

Yeah, I would probably put it closer to the negative five.

Ifran Doza - Romantic Management

Okay.

Scott Morris

As to where we think will be based on our current forecast.

Ifran Doza - Romantic Management

Got it. And on a follow-up to this question, can you help me understand how sensitive is your guidance range to the ERM? What I mean is that, if you take a look at your utility guidance, which is between 1.20 to 1.40. I mean, how much do you have to, I guess, if you for example stay at that negative five range, what does that imply in that range, does it imply the midpoint and if you were to stay below the negative five, what would it imply and staying above? So I’m just trying to get a better understanding, how does your current guidance is sensitive to the true up of the ERM from the negative side?

Scott Morris

Well, the good news is that we have some things going the other direction and that’s been helpful to us, most significantly that gas loads. We had higher gas loads in the first four months of the year and we were expecting to have and so that in and of itself has offset a fairly significant portion of the loss that we expect to absorb in the ERM. We also have lower depreciation rate as result of some negotiations we have done with the commissions, and so both of those things are helping us to really feel like we are still pretty close to the middle of the range.

And we had some good discussion internally about should we narrow the range. We’ve needed to leave the range as wide as it is, because we still could have a fairly significant amount of variability as a result of where we are in the ERM. We think, if we end up with some good strong hydro conditions in the fourth quarter then we are going to be back to the point where that’s going to be dollar for dollar impact to the shareholders and could be a very positive thing.

Based on where we think we’re going to be at this point, with a potential for around a $5 million loss in the ERM, I feel pretty good that we’re going to be around the midpoint of the range. So there’s still quite a bit of variability, but we have got some offsets here, as I guess, what I’m trying to stress with you.

Ifran Doza - Romantic Management

That is very helpful. I just had one last question, obviously, Starbucks closing lot of their stores, you guys know it very well, given you are in the region. I wanted to get your sense as to what impact, the economic slowdown is having on small businesses, and what are the impacts you guys are seeing on the Advantage IQ business and I just used the Starbucks closing as an example of the impact that we are reading about, I mean, do you guys have any thoughts you can share?

Scott Morris

Sure. From the Advantage IQ perspective, I just had a discussion about that with Stu, just last week. Well, obviously Stu thinks, any shutting -- shutting down any business isn’t good for Advantage IQ. He wasn’t particularly concerned because they are having enough offsets of other growth areas that the impact should be minimal on Advantage IQ’s business going forward. The contracts for Starbucks are extremely competitively priced, so if we lose some stores that is not going to have a major impact.

And as far as our service territory is concerned, our economy usually lags the national economy by anywhere from 12 to 18 months and we have seen a little bit of a slowdown from our housing perspective and some of that. But we’re not seeing a significant amount of trouble in our economy here in our service territory, as a matter of fact, manufacturing stayed strong. We have got a lot of commodities that are quite high that, in our service territory, agriculture, wheat for example, metals or mining. So, a matter of fact, in some cases we are quite strong and we can’t find workers to fill some of those jobs. So we’re not in terrible shape.

Ifran Doza - Romantic Management

Thank you for your time. I appreciate it.

Scott Morris

Thank you.

Operator

Our next question will come from the line of Eric Beaumont of Copia Capital. Please proceed.

Eric Beaumont - Copia Capital

Good morning, guys. How are you?

Malyn Malquist

Good morning, Eric.

Scott Morris

Hi, Eric.

Eric Beaumont - Copia Capital

Quick question, change in tax from some of the others. Obviously a lot going on in the regulatory calendar, and historically when you have gotten trued up it has been difficult for you to earn your allowed, obviously that’s been more skewed towards Washington given the more frequent cases in Idaho. Can you just kind of walk us through your thinking of the timing of one thing is getting placed and how realistic earnings close to allowed or what do you think based on lag is going forward?

Kelly Norwood

This is Kelly Norwood. As you know, we have two cases pending right now. In Idaho, we filed in April; we just mentioned today on the call that staff has essentially completed their audit and they have notified the Commission that they are ready to talk settlement and we’ll actually start that tomorrow. Now if we run the full course that would be November of this year before we get an order, but we are hopeful that we’ll make some progress on settlement discussions.

Now when we complete that case that’s going to reset the base for a PCA and what we do in our cases as is we pro forma our future salaries in Idaho, they have been somewhat receptive to also putting in the capital that we spend all the way through the end of ‘08. Now it remains to be seen where you land on that, but we have made a lot of efforts try to put in all the known future costs that we are going to incur, during the period the rates will be In effect. So in these cases we should be set up pretty well to be able to earn closer to our allowed return, once rates are put into effect. The one variable that we’ve already talked about is natural gas prices and hydro conditions, which obviously will fluctuate, depending on what precipitation is.

Eric Beaumont - Copia Capital

And I mean, obviously in Idaho that seems well. In Washington, we have hit a few snags in the past. Are you seeing better traction on getting more up-to-date pro forma capital as well there, and obviously as far as long, so we are not sure, but, is your expectation that you will have more forward looks to the capital and costs in Washington?

Kelly Norwood

All I can say at this point is that we are hopeful that they will recognize, given the dollars that all utilities are spending today on capital that they’ll recognize that and put that in the rates, otherwise there just isn’t an opportunity to earn a return on that. We haven’t seen a lot of pushback yet, but again we’re pretty early in the game at this point.

Eric Beaumont - Copia Capital

Okay. And just for the timing on Washington, can you refresh my memory there?

Kelly Norwood

Yes. We are fairly early that we have settlement discussions that were in the original procedural schedule, which will start August 20. Staff and Intervenor testimony will be September 12. And if we go to full statutory period, it would be 1st of February before we would get an order.

Eric Beaumont - Copia Capital

Okay, great. Thanks, I appreciate the time.

Scott Morris

Thanks, Eric.

Operator

Our next question will come from the line of [David Thickens of Deephaven]. Please proceed.

David Thickens - Deephaven

Good morning.

Scott Morris

Well, David, hello.

David Thickens - Deephaven

How are you?

Scott Morris

Great.

David Thickens - Deephaven

David asked a couple of my -part of my questions. But what I would like to do, I realized you haven’t given guidance. But as we think to ‘09 and start looking forward, what are the major drivers we should be thinking of other than any potential benefits from your two rate cases that you filed? Can you talk a little bit at all about O&M trends or other drivers we should be incorporating into our thinking?

Malyn Malquist

David, this is Malyn. I think that the biggest issue really is how do we do in our rate cases? Because we are spending a pretty significant amount of capital and if you look at the capital that we are spending after depreciation, we are looking at five to 7% kind of increases in rate base, and so the question is how much of that can we get, what kind of lag are we going to experience. If we can get timely rate relief, and recognition of that and one would expect that, that would translate to the bottom line.

We are clearly seeing some inflationary impacts in the costs of doing business. Of course like everybody else, gasoline -- our fleet used $1.2 million more gasoline in the first six months than what we budgeted. And so we’re seeing some impacts like that. But the majority of the inflationary impacts are coming in the costs of copper, steel, transformers, the cement, asphalt, the things that we need to use and buy to essentially do the capital projects that we’re doing.

So the impact really comes longer term through upward pressure on the capital budget, more so than on the operating budget. And our labor costs are going to be the normal kind of wage increases that are built into our union contracts are in-line with normal inflation. Our other costs, healthcare costs are going higher than that, but controllable. And so really, the area that we are most concerned about is the impact long-term on capital budget.

Scott Morris

David, I would just add that we have been able to leverage technology to drive costs out of our business. We have implemented a new website where customers can do pretty much all of their transactions online, and we have been able to continue to flatten or reduce our call center expenses. We have also installed mobile dispatching features at our natural gas business that continued to optimize the use of our gas servicemen and increased productivity and drive costs out of that business.

We also have some opportunities to do that on the electric side over the next couple of years. So, we have also -- we’re installing a new interactive voice system for our customers begin to drive more costs out of the system. So we are pretty innovative around ways to leverage technology to continue to streamline our operations.

So while maybe we can’t completely offset all of the factors that Malyn has talked about, we’re certainly trying to drive costs out of our business to stay as focused on that as possible, while increasing customer service and customer satisfaction. We are not sacrificing that to drive costs out; as a matter of fact, we’re doing both. And we are doing, I think, quite well.

David Thickens - Deephaven

Okay. Just as a -- maybe another angle, some of the previous questions about trying to reduce the lag. Have you had specific conversations with the regulators that have led you to put certain mechanisms into your rate case requests, or is this more of a case of -- you are just trying different approaches and seeing what is going to stick?

Kelly Norwood

Kelly, again. Let me give you a couple of examples. In Idaho Power’s last rate case, they filed what they called a half a projected rate year and half was based on actuals. And their objective was to pro forma in future capital and I don’t know if that was that well received, because they were using a budget, or a projected numbers. In Washington, a couple of years ago Puget proposed what they called a Distribution Tracker, and they did not receive approval of that.

So, what we did was step back, we did talk to staff ahead of time in Washington and Idaho, and let them know what our approach was, and why we were taking that approach. And what we did was, we started with actual numbers during the historical test period 2007. And then we have put in there adjustments based on known capital expenditures, and then future capital expenditures based on specific projects. We think that that is a much more attractive way to go, and one that the staff has an audit trail to follow, and I think that is why the initial indication, in Idaho anyway, is that they may be receptive to that, although, we will have settlement discussions here pretty quick. And we think that it has a reasonable chance of getting at least some progress in the state of Washington also.

David Thickens - Deephaven

Okay. Thank you.

Kelly Norwood

You’re welcome.

Operator

Our next question will come from the line of Paul Patterson of Glenrock Associates. Please proceed.

Paul Patterson - Glenrock Associates

Good morning, guys.

Scott Morris

Hi, Paul.

Malyn Malquist

Morning, Paul.

Paul Patterson - Glenrock Associates

Really quickly. I’m sorry if I missed this. It sounds like you guys had updated your filings on Monday, and the electric numbers had increased to 47.4, and I think the original number was around 37 million, is that right?

Malyn Malquist

Yes.

Paul Patterson - Glenrock Associates

And I’m sorry, I missed it -- what was it again that caused the increase?

Malyn Malquist

The primary driver was the increase in natural gas costs. When we filed originally in Washington, the cost of natural gas we had in there for Coyote Springs was $7.90 per dekatherm, and what we updated the cost to was $9.05 per dekatherm. And so that’s the primary driver in updating the numbers.

Paul Patterson - Glenrock Associates

Okay. But you’re not increasing your request, did I hear that right, or ... I’m sorry?

Scott Morris

That’s correct. What we’re doing is increasing the dollars of that. We think we can justify to show Commission, and we’re hopeful that that will help us to get a result that’s closer to the original ask of 36.6 million that we have originally filed.

Paul Patterson - Glenrock Associates

Okay, I see. And then if I understood you guys correctly, when you add up your guidance by segment, it looks like it’s a little -- it doesn’t seem to actually match the consolidated number. Is that because you guys are actually seeing better-than-normal results in the Other segment?

Malyn Malquist

That’s a piece of it Paul. I think we try to look at best guess probability of the upsides of all the businesses and the downsides of all the businesses. And when we look at that, it didn’t just add up based on the segment guidance. And so it comes out a little bit different. I hope that makes sense.

Paul Patterson - Glenrock Associates

Okay. I will follow up afterwards, I guess. The other thing is the settlement discussions in Washington. You mentioned the ones in August, there is also, I think, you have scheduled something for October?

Malyn Malquist

That is correct.

Scott Morris

Correct. October 22 is the scheduled settlement conference.

Paul Patterson - Glenrock Associates

What’s the chances I guess, or how would you handicap the possibility of you having a settlement before staff files testimony or the other -- ?

Scott Morris

At this point it’s pretty hard to tell it’s pretty early in the game. So I wouldn’t want to guess.

Paul Patterson - Glenrock Associates

Okay. But it sounded like you guys were feeling a little bit more confident in Idaho, is that -- did I get it correctly or is that just -me reading something ... ?

Scott Morris

Yes, and the reason we say that is because the staff was the one that actually took the initiative to send a letter to the Commission stating that they planned to engage in settlement negotiations with Avista, so they took the initiative to do that and that’s positive.

Paul Patterson - Glenrock Associates

Okay, great. Thanks a lot.

Scott Morris

Thank you.

Operator

Our next question will come from the line of James Bellessa of D.A. Davidson & Co. Please proceed.

James Bellessa - D.A. Davidson & Co.

Good morning. Most of my questions were answered. But I do want to check. You really think you’re going to have an ERM benefit in the third quarter. I have been guessing that, but there were something said that kind of suggested maybe not?

Malyn Malquist

I believe that we will gain back in the third quarter some of what we lost in the fist two quarters, Jim.

James Bellessa - D.A. Davidson & Co.

In the Cadence acquisition, said to be 0.01 to $0.02 dilutive, is that all a third quarter event?

Scott Morris

No, that’s for third and fourth quarter.

James Bellessa - D.A. Davidson & Co.

And why is it spread over the two quarters, what happens?

Scott Morris

Well, there is more in the third quarter because we will take the transaction cost all in the third quarter. But the Cadence business isn’t bringing enough net income to offset the dilution. There are -- it’s interesting they are about where our advantage was three or four years ago, in terms of their -- progress of the company and their profitability and we think that the acquisition will allow us to make their business much more profitable in the long-term. But in the short-term it’s dilutive to give up 25% of the company and not have enough earnings coming in from them offset it.

James Bellessa - D.A. Davidson & Co.

Thank you.

Scott Morris

You are Welcome.

Malyn Malquist

Thanks, Jim.

Operator

Our next question will come from the line of Steve Gambuzza of Longbow Capital.

Steve Gambuzza - Longbow Capital

Good morning.

Malyn Malquist

Hi, Steve.

Scott Morris

Hi, Steve.

Steve Gambuzza - Longbow Capital

When will the wind capacity that you talked will come online?

Scott Morris

The 50 megawatts would come online in early 2012. We have to have it online by 2012 to meet the renewable portfolio stand that was set in the state of Washington, that 50 megawatt of capacity will be about 15 average megawatts of energy.

Steve Gambuzza - Longbow Capital

Okay. Did you notice any unusual trends or any pickup in bad debt expense during the quarter?

Scott Morris

No, we have not experienced that.

Steve Gambuzza - Longbow Capital

Okay, thank you

Scott Morris

Welcome.

Operator

We have a follow-up question from the line of Paul Ridzon of KeyBanc.

Paul Ridzon - KeyBanc

When would you expect a quick decision in Washington?

Malyn Malquist

That should come within the next month and we haven’t heard any concerns about that, in fact the initial indication was that it made sense, and we’ll see.

Paul Ridzon - KeyBanc

And then you got, I guess, two million shares on your shelf. Do you expect to issue those all by year-end?

Scott Morris

That -- we haven’t made that determination yet, Paul. I do think that we will issue a good portion of it, but I don’t know that we’ll issue all of that.

Paul Ridzon - KeyBanc

And then lastly, just any update on conservation trends?

Malyn Malquist

Well, a couple of things about it. We have not seen significant price elasticity because we obviously we had some rate increase in Washington, but the matter of fact we have seen loads continue to increase on the electric side of our business, primarily because of a lot of the gadgets that homes are incorporating, I mean, plasma TVs, computers and other things. So the plug-in load has continued to increase.

And also on the natural gas side, we have seen a little bit of a decrease, but not significant. We have stayed fairly aggressive with energy efficiency programs and we will continue to do that because -- and work with our commission, because it is the right thing to do in this rising price environment. So, we think we have got the regulatory model in place that helps us meet our customer’s expectations on energy efficiencies, but does not impact our investors significantly.

Paul Ridzon - KeyBanc

Where does decoupling stand in Washington State?

Malyn Malquist

We have decoupling on the gas side of the business, and it is a pilot program, we are pleased with how that mechanism has worked on the electric side. At this point, I don’t see any electric decoupling in the immediate horizon, but that’s not to say that, from a policy perspective the State won’t continue to talk about that. I think with renewable portfolio standards, Washington’s desire to continue to be green. I think, the policy debate will continue and I think decoupling will become more and more of an item here in the state, but probably not for a year or two.

Paul Ridzon - KeyBanc

Okay. Thank you.

Operator

This concludes the question-and-answer portion of today’s conference. I will turn the call back to management for any closing remarks.

Scott Morris

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

Operator

Thank you for your participation. You may now disconnect, have a great day.

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Source: Avista Corp. Q2 2008 Earnings Call Transcript

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