Avista Corp (AVA) 2006 Q2 法說會逐字稿

Ladies and Gentlemen and welcome to the Second Quarter 2006 Avista Corporation Earnings Conference Call. My name is Sherelle and I will be your coordinator for today. [OPERATOR'S ISTRUCTIONS]. As a reminder, this call is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's call, Mr. Jason Lang, Manager of Investor Relations. Please proceed, sir.

Thank you, Sherell. Good morning, everyone. Welcome to Avista's second quarter 2006 Earnings Conference Call and webcast. Avista's earnings were released pre-market this morning and the release is available on our website at avistacorp.com. Joining me this morning are Avista Corp. Chairman of the Board and CEO, Gary Ely; President and COO, Scott Morris; Executive VP and CFO, Malyn Malquist; the President of Avista Energy, Dennis Vermillion and Avista Corp. Vice-President and Controller, Ann Wilson.

As a note to those of you on the webcast, we'll be advancing the slides automatically during the course of the presentation. The slides can be downloaded on our website at avistacorp.com. There will also be a replay of today's webcast available on our website later today.

Before we begin, I'd like to remind you that some of the statement's that will be made today are forward-looking statements and involve risks and uncertainties which are subject to change. For reference to the various factors which cause actual results to differ materially from those discussed in today's call, I would direct you to Avista's 2005 Form 10-K and Form 10-Q for the quarter ended March 31, 2006 which are available on our website.

Now, I'd like to turn this over to Avista's Chairman of the Board and Chief Executive Officer, Gary Ely.

Thanks, Jason. Good morning, everyone. We are on track for a good year in 2006 due to improved year-to-date earnings from Avista Utilities and a continued trend of earnings growth from Advantage IQ, the new name for Avista Advantage. I'm also satisfied with Avista Energy's operations as measured on an economic basis.

Our utility operation had a strong first half of 2006 due in part to the benefit of lower electric resource cost and the positive effect under the Washington Energy Recovery Mechanism, or ERM. In June, the Washington Commission approved our all-party settlement agreement with respect to the modification of the ERM. Scott Morris will discuss this further in a couple of minutes.

Also contributing to the increase of net income for the first half of 2006, was the general rate increase implemented in Washington on January 1, 2006 and the sale of claims against Enron Corporation and certain other affiliates during the first quarter.

Another contributor to our consolidated earnings growth for the first half of 2006 was Advantage IQ. To more effectively communicate it's identity in the marketplace and to enhance the understanding of the services they provide, Avista Advantage has recently changed its name to Advantage IQ. Malyn Malquist will provide more details on the performance of Advantage IQ later in the call.

While Avista Energy’s reported results continue to be volatile in part due to the required accounting for certain contracts and assets under management, we are satisfied with the results from this business during the first half of the year as measured on an economic basis. Timing differences associated with the accounting for these contracts and assets under management resulted in Avista Energy recording a net loss in the second quarter of 2006. Dennis Vermillion will have further explanation on the results of Avista Energy in a few minutes.

Overall, we are on tack to meet our consolidated earnings target for 2006. However, we expect that earnings will be lower for the second half of the year as compared to the first half of the year. This is primarily due to the historically based seasonal decline in the third quarter earnings for Avista Utilities and the potential to reverse a portion of the benefit received under the ERM during the first half of the year as streamflows and hydroelectric generations decrease.

Earlier this year, we told you of our proposal to proceed with a statutory share exchange, which would change the Company's organization to a holding company structure. As proposed, the holding company would ultimately become the parent of Avista Utilities and Avista Capital. At Avista Corp.'s annual meeting in May, shareholders approved the proposal.

We also received approvals from the Federal Energy Regulatory Commission and from the Idaho Public Utility Commission. The statutory share exchange is subject to the receipt of regulatory approvals in Washington, Oregon and Montana, and the satisfaction of other conditions. The Company anticipates that the statutory share exchange will not be completed and the holding company structure not implemented earlier than the fourth quarter of 2006.

In June, Jesse Knight resigned from Avista's Board of Directors following his accepting a position as an Executive Officer of Sempra Energy. Jesse served on Avista Corp.'s board for seven years and was a great asset during some very difficult times. Although we are sorry to see him go, we wish Jesse the greatest success at Sempra and in all of his future endeavors. At this time, the Board of Directors has not selected a replacement for Jesse. I personally will miss Jesse and wish him the very best.

In May, Scott Morris was named President and Chief Operating Officer of Avista Corp. and Malyn Malquist was named Executive Vice President and Chief Financial Officer. These new titles reflect an increased level of responsibility for these individuals and are part of our leadership development and succession planning process.

I am pleased with the progress that we have made on all fronts and I expect that trend to continue. Now, I'd like to turn the call over to Scott Morris for his report. Scott?

Thanks, Gary, and good morning. Avista Utilities contributed $0.34 per diluted share for the second quarter of 2006, compared to $0.38 per diluted share for the second quarter of last year. It's important to note that results for the second quarter of last year included the $3.2 million pre-tax gain from the sale of our South Lake Tahoe natural gas distribution properties.

For the first half of 2006, Avista Utilities contributed $0.87 per diluted share, an increase from $0.76 from the same period of 2005.

The increase in our year-to-date results was partially due to our electric resource costs being lower than the amount included in base retail rates. This was primarily due to improved hydroelectric generation from higher than normal precipitation and snowpack, resulting in increased stream flows to our hydro generating facilities during the first half of 2006. As a result, we recognized the benefit of $7.2 million or about $0.10 per diluted share on a net-of-tax basis under the ERM during the first half of 2006 as compared to $700,000 in the first half of 2005.

In June, the Washington Utilities and Transportation Commission approved the modification of the ERM through a settlement agreement between Avista and the other parties in the proceeding. The settlement agreement provides for the continuation of the ERM with certain agreed-upon modifications and was effective retroactive to January 1, 2006. The settling parties have agreed to review the ERM after five years.

Under the modified ERM, Avista's annual deadband is reduced from $9 million to $4 million. Annual power supply cost variances between $4 million and $10 million will be shared between Avista and customers on a 50-50 basis. If annual power supply costs vary from the amount included in base rates by more than $10 million, 90% of those costs will be deferred for future surcharge or rebate and the remaining 10% of the variance above $10 million is an expense of, or benefit to Avista without affecting current or future customer rates.

We believe the modified ERM better balances the interests of the Company and our customers by reducing the volatility in Avista's earnings that has been caused by variations in prices for fuel and purchase power, as well as the availability of hydro generation.

It's important to note that the power supply cost variance is ultimately calculated on a calendar year basis and can change significantly during interim periods of the year. As such, the power supply cost variance and the resulting calculations under the ERM will most likely be different at the end of 2006 as compared to the end of the second quarter.

Based on actual generation for the first half of the year and with the assumption of normal precipitation for the second half of the year, we're expecting hydro generation to be 104% of normal in 2006. This is good news as our hydro generation has been below normal in five of the past six years.

However, conditions can change substantially throughout the year and our forecasts may change based on precipitation, temperatures and other variables. It's particularly difficult to predict hydro generation for the fourth quarter at this point in time.

On July 24, after several days of extremely high temperatures in eastern Washington and northern Idaho, Avista's retail native load peaked at 1,642 megawatts, an all-time high for Avista's summer load. Due to the high loads and some short-term plant outages, we needed to make unplanned power purchases in the wholesale market. Short-term prices were extremely high as electrical supplies were stretched across the West because of the record high temperatures and strong demand. To minimize the amount of unplanned purchases, we went to our customers through personal contact and media and requested their voluntary conservation of energy on both July 24 and 25. I'm pleased to report that our customers responded by cutting load by approximately 30 megawatts and thus our conservation request was successful. The reduction in loads not only contributed to our ability to continue to provide reliable service to our customers, it also reduced the overall cost of providing service during this time period.

Let me give you an update on the relicensing of our Spokane River hydro facilities, which represent approximately 16% of Avista's current hydro generating capability. Avista's current license expires on August 1, 2007. We filed new license applications with the FERC in July of 2005. Avista has requested the FERC to issue separate licenses for the Post Falls facility and the other four hydro plants on the Spokane River because this facility presents more complex issues that may take longer to resolve than those associated with the rest of the Spokane River Project. The Post Falls facility, located in Idaho, represents less than 2% of Avista's hydro generation capability and approximately 1% of our total generation capability.

In July, Avista entered into an agreement with the Bureau of Land Management with respect to specific measures related to the Post Falls facility. Such measures will become part of the new operation license, if approved by the FERC and are not expected to result in material costs to the company.

Following a May 2006 notice from the FERC, with a July 17 deadline, numerous comments, recommendations, terms and conditions and prescriptions regarding our license applications were are filed with the FERC by various parties, including the Coeur d’Alene Tribe, the State of Idaho, Washington State agencies, and others. In addition, the United States Department of Interior filed proposed mandatory conditions for the Post Falls facility. The DOI's conditions appear to be particularly onerous and go beyond what we believe is reasonable. The DOI's filing could lead to a trial-type hearing on facts in front of a DOI administrative law judge. If Avista cannot reach a satisfactory resolution with various parties, the licensing process could result in legal proceedings at the FERC or in court.

At the midpoint in the year, we've spent approximately $70 million of our $160 million utility capital budget. Significant investments for the year include the continued enhancement of our transmission system, ongoing installation of advanced meter reading technology and upgrades to our hydro generation facilities.

In May, we began construction of a 60-mile transmission line between Rosalia, Washington and Lewiston, Idaho. This $40 million project will provide additional transmission capacity and improve reliability for the Palouse region. We expect it to be completed in 2007. This is the last major phase of our transmission enhancement project that began in 2003

We plan to continue to invest in our generation, transmission and distribution systems in order to meet our load growth needs and to continue to provide continued reliable service to all of our customers.

Now I'll turn the call over to Dennis Vermillion for a report on Avista Energy.

Thanks, Scott. Good morning. The Energy Marketing and Resource Management business segment, which primarily consists of Avista Energy, had a net loss of $0.09 per diluted share for the second quarter of 2006 compared to a net loss of $0.01 per diluted share for the second quarter of last year. For the first half of 2006, the segment contributed $0.01 per diluted share compared to a net loss of $0.18 per diluted share for the first half of 2005.

The net loss recorded for the second quarter of this year was due to the differences between the economic management and the required accounting for certain contracts and physical assets under the management of Avista Energy.

The operations of Avista Energy are managed on an economic basis, reflecting contracts and assets under management at estimated market value consistent with industry practices. These differences primarily relate to Avista Energy's management of natural gas inventory and its control of natural gas- fired generation through a power purchase agreement, as well as certain other agreements, including natural gas pipeline transportation agreements. These differences had an estimated $7.9 million after-tax negative effect on results for the second quarter of 2006 compared to an estimated $2.3 million after-tax positive effect on results for the second quarter of 2005. For the six months ended June 30, 2006, these differences reduced net income by an estimated $5.3 million as compared to a decrease of an estimated $3.9 million for the six months ended June 30, 2005.

The second quarter is historically a low earnings quarter for Avista Energy due to the difficulty in recovering demand charges it pays for thermal generation it controls through a power purchase agreement related to the Lancaster Project. Because of the availability of relatively low-cost hydroelectric generation during the period, sales of energy from thermal generation are generally lower this time of year than during other time periods. Avista Energy actively hedges the value of the power purchase agreement related to the Lancaster Project for delivery periods throughout the year when opportunities arise in the market. Although the power purchase agreement is not a derivative and is not marked-to-market, the hedging contracts are reported at estimated market value. Hedge accounting is generally not applied during the second quarter because of the inability to predict whether the plant will operate, which is heavily impacted by hydro conditions. Not applying hedge accounting results in gains and losses recorded in periods prior to the delivery, such as the second quarter. 'The fixed demand charges from the power purchase agreement are accounted for when incurred. This results in an earnings timing difference which was exaggerated during the second quarter because there were insignificant sales of power from the Lancaster Project due to the availability of hydro power. This timing difference, as well as the inability to record our natural gas storage and natural gas pipeline contracts at market value, both of which we actively enter into hedging contracts, resulted in an estimated $7.9 million after-tax negative effect on results.

Economic results for this segment were consistent with the Company's expectations for the first half of 2006. A significant portion of the estimated $5.3 million difference between the economic management and the required accounting for certain contracts and physical assets under management for the first half of 2006 is expected to reverse in the first half of 2007 when the contracts are settled or realized. This assumes stable commodity prices and no additional transactions by Avista Energy. Until the contracts are settled or realized, this difference could also increase or decrease due to changes in forward market prices.

Based on our economic results for the first half of the year, we are on target to meet our earnings forecast for 2006 excluding the effect that changes in energy prices have on the difference between the economic management of our business and the required accounting for certain contracts and assets under management. At this point, I'll turn it over to Malyn Malquist.

Well, thanks, Dennis, and good morning everyone. Avista Corp. had net income of $13.5 million, or $0.27 per diluted share, for the second quarter of 2006, a decrease from $18.6 million, or $0.38 per diluted share, for the second quarter of 2005. On a year-to-date basis, net income was $45 million, or $0.91 per diluted share, an increase from $28.8 million, or $0.59 per diluted share, for the first half of 2005.

I'll provide an overview of financing activities, cash flows and the performance of Advantage IQ and the Other business segment, as well as our earnings forecast.

Our total debt outstanding decreased approximately $64 million in the first half of 2006, primarily due to operating cash flows in excess of utility capital expenditures, dividends and other funding requirements. Our debt to capitalization ratio has decreased from 60.2% at the end of 2005 to 57.4% at June 30, 2006. For the remainder of the year, we expect net cash flows from operating activities and our committed line of credit to provide adequate resources to fund capital expenditures, maturing long-term debt, dividends and other contractual commitments. However, we currently expect to issue long-term debt in the fourth quarter of this year, primarily to fund debt that matures in January of 2007.

As evidence by the progress we made, last Friday, Fitch Ratings revised their outlook to Positive from Stable.

Even though we've reduced debt levels, our interest expense increased $1.7 million for the first half of 2006 as compared to the first half of 2005. This was primarily due to two factors. First, an increase in interest rates has increased interest expense on variable rate long-term debt to affiliated trusts. Second, during the first half of 2005, we carried higher levels of short term borrowings under our committed line of credit at relatively low interest rates of around 4%. During the fourth quarter of 2005, we essentially refinanced these borrowings on a long-term basis at a fixed rate of 6.25%. Although this was a prudent long-term financing decision, it has resulted in an increase in interest expense for 2006 as compared to 2005.

As previously reported, we agreed to increase our utility equity component to 35% by the end of 2007 and 38% by the end of 2008 in our Washington general rate case settlement. Failure by the Company to meet those targets could result in a reduction in base rates by 2% for each target. The utility equity component was approximately 34% as of June 30, an increase from 31% at year-end 2005.

Beyond expected earnings, we continue to evaluate and implement measures to increase our utility equity ratio. During the first quarter of 2006, we began delivering original issue shares under equity compensation plans.

With respect to other cash flows, deferred power and natural gas costs were reduced by $38 million during the first half of the year primarily through recovery from customers. As of June 30, 2006 our total deferral balances were approximately $110 million, a decrease from over $250 million at the end of 2001.

I'm pleased to report that Advantage IQ continues its trend of earnings growth. The Company contributed $0.03 per diluted share to earnings in the second quarter of 2006 and $0.06 per diluted share on a year-to-date basis.

Advantage IQ's revenues increased by 25% for the first half of 2006 as compared to the first half of 2005. During the six month ended June 30, 2006, Advantage IQ processed bills totaling $5.1 billion, an increase of $840 million, or 19% as compared to the six months ended June 30, 2005. The number of build sites increased by approximately 30,000, or 19%, during the 12-month period ended June 30, 2006.

As I mentioned during the May earnings call, Advantage IQ is considering certain strategic investments aimed at creating long-term savings that may increase costs in the short term through up-front expenditures. This could limit earnings growth during the second half of 2006 while enhancing Advantage IQ's long-term profitability.

In the Other business segment, results improved slightly as Advanced Manufacturing and Development, which does business as MetalFx, had positive earnings in each month of the first half of 2006. This was a significant improvement from last year's results.

Looking at our 2006 guidance, we are confirming our outlook for Avista Corp. consolidated earnings in a range of $1.30 to $1.45 per diluted share. We expect Avista Utilities to contribute in the range of $1.00 to $1.15 per diluted share. The outlook for the utility assumes, among other variables, near normal weather, temperatures and hydro generation for the remainder of the year. I would like to remind you that the third quarter is often a negative quarter for the utility, primarily due to low natural gas loads and relatively high electric resource costs due to reduced hydro generation.

The outlook for the Energy Marketing and Resource Management segment is a range of $0.20 to $0.30 per diluted share excluding any positive or negative effects related to the required accounting for certain contracts and physical assets under management.

We expect Advantage IQ to contribute in a range $0.10 to $0.12 per diluted share and the Other business segment to lose $0.05 per diluted share for 2006. Now, I'll turn the call back to Jason.

Thank you, Malyn. At this time we'd like to open this call up for questions.

Thank you. [OPERATOR'S ISTRUCTIONS]. Your first question comes from the line of Paul Patterson from Glenrock Associates. Please proceed.

Good morning, guys.

Good morning, Paul.

I just wanted to sort of go over the trading and marketing, make sure I completely understand it. It looks to me like the economic earnings was about $0.07 for the quarter, if we back our the $0.16 of accounting, is that correct?

Yes, that's correct.

Okay. And about -$0.06 for '05?

That’s correct, Paul.

And $0.12 versus -$0.10 for the six month period. What I'm not completely clear on is – it was a pretty elaborate explanation of the accounting, but what actually is driving such a big improvement outside of the accounting?

I'm sorry. Let's have Dennis answer that.

On an economic basis, which is of course the way we manage the business, we've seen a significant improvement in our natural gas side of our business as we've talked about in prior calls, we struggled a bit in some of our gas trading activities last year. We scaled that back substantially and although our profits from that part of our business are modest so far this year, the turnaround from last year is a big change. Of course, there are other components to that part of our business. We have storage assets that we manage, as I mentioned. We also have end-use businesses in Canada and now in Montana and also end-use customers in the Pacific Northwest. All of those, and we manage natural gas pipeline capability, as I mentioned also. All of those other things combined are doing very well this year, as well. On the power side, we got off to a bit of a slow start but our power trading and asset optimization on that side of the business is performing well. That is similar to what they were doing last year, so that's not a big turnaround. Another thing that is different is our Lancaster project. Last year and in years past we've struggled to recover the demand charges associated with that asset and this year we have already recovered all the demand charges and are doing much better or well ahead of where we expected. So, all of those things combined have summed up to get us off to a very nice start for the first half of the year. And, I'm real pleased with the turn around after our performance last year, so I think we're headed in the right direction.

Okay. That's very helpful. Let me ask you something now. With these economic numbers, the numbers excluding the accounting adjustments that you went through, the $0.16 and the $0.11, if we take the normal numbers, how much are they impacted by marked-to-market accounting or the booking of value now with respect to contracts that you entered into but are going to realized at a later period?

Well, on an economic basis, we do manage our portfolio on a marked-to-market basis, so any deal that is entered into is marked-to-market day one.

How much of it is unrealized, I guess?

Oh, unrealized.

You can get back to me on that. I don't know if, because you have to back out the other thing and what have you, whether or not you have the number, but I was just wondering because it is such a dramatic improvement. It sounds like there are a lot of operational issues. I was just wondering if there is any benefit that you are seeing here from booking value in the future.

While they are looking that up, Paul, we'll answer that. Do you have another question?

No, I think that's about it. I think you guys went over it pretty thoroughly. Thank you very much.

Thanks, Paul.

Your next question comes from the line of Paul Ridzon from KeyBanc. Please proceed.

Good morning. I have a few questions. I was looking at the utility tax other than income and noticed that it is up significantly. Wondering if that's a timing issue and is that a pass-through that's earnings neutral?

Ann?

Other than income taxes is primarily due to higher retail revenues and it is – hang on, just one second. Let me look at something.

While she's looking that up, Dennis, why don't you go ahead and answer Paul's question.

Yes, I guess maybe the best way to answer that is most of the unrealized earnings are current so that means it's in the front year and so it would be realized within the next 12 months. Hopefully that helps.

And that increase in other than income taxes is due to the higher retail revenues and it is pass-through. Does that answer your question?

Yes, it does. Thank you. The other is, we just got off the line with NiSource who told a very gloomy tale about demand destruction and said it’s a nationally widespread phenomenon. I was just wondering what percent are you seeing it?

We have seen some demand destruction in our area where we have our large industrial transportation customers, particularly in the state of Oregon, but I would say with our residential commercial loads, we have not seen significant demand destruction. It hasn't materialized here.

In fact, if you look, we had our highest peak, although the hot weather certainly contributed to that but we saw no real fall off of use per customer during that.

But what are you seeing with regards to the forced disconnects?

Define "forced disconnects" for me, would you, Paul? What do you mean?

I don't pay my bill so you come around with a big wrench and turn off my gas.

As a matter of fact, we are very pleased with our write-offs. They are actually better this year than they were last year. So with increased energy prices, our customers are keeping current or even doing a better job than they were last year. So, again, no significant issues with that at all.

Relative to your guidance, where are we year-to-date?

Well, Paul, I would say that we are running better than expected on the utility business. We are running a little bit ahead in that segment and we're running a little bit behind, we are obviously running behind on a gap basis for Avista Energy. We are actually right in the middle of the range for where we would expect them to be on an economic basis.

Do you have a cents per share where we are? Just on your, in the same basis that guidance is formatted in which, I believe, is excluding marked-to-market?

Excluding marked-to-market. Well, if you do the math, they are right in the middle of the range for what we would have expected for the first half of the year. So if you divide it in half and put it right in the middle of the range, that's where Avista Energy is.

My math is showing about $0.98 year-to-date. Is that? I'm also backing off the Enron gains in the first quarter.

I'm sorry, on an economic basis, I haven't done that in my head. I'd need to think about that for a moment. Why don't you go with your next question.

Well, my next question is kind of tied to that in why you are not raising guidance?

Well, I think that – Malyn mentioned this in his, but usually our third quarter – I shouldn't say usually, but at least – I've been here almost 40 years now and usually the third quarter is about half of the time negative at the utility. Not sure where the marked-to-market is going on Energy as far as the things that we have in our storage and other things as far as whether that's going to go up or down. I think Facility IQ is solid, they'll continue to come in as where we forecasted but I would expect the third quarter probably could possibly even back up a little bit from where we're at right now. That's one of the reasons we are not raising guidance. Because all of our, most of our revenues and earnings comes in the first and the fourth quarters of the year.

All right. There has been past discussion that you were looking at equity markets. I guess the progress you've made against your regulatory requirement has you pretty confident that you're going to hit those goals?

I'm much more confident than I was, but we've seen the benefit of a slightly above normal hydro year. I was about to say a really good hydro year because it is compared to what we had the previous few years and my nervousness would be around what happens next year? If we have a subpar hydro year, which seems to be the pattern that we were in, then I would have some concern about hitting those targets without doing some additional equity through a durable plan or something like that, so we’re – we're trying to be ready but I am very pleased with the progress that we've made this year.

Incremental capital at IQ – how soon to be thinking about that with relation to past statements that that might be a valuable asset to monetize?

I don't believe that they will need any additional capital to do the kinds of things that we’re talking about are having them do. They're basically generating cash. In fact, they've been paying down some inter company debt that we've had there. Regarding a future monetization event, we continue to look at that as probably still, business is probably still not quite large enough to really look at that at this point in time, but I think in the next couple of years, it certainly could be a strategy that we might employ.

Thank you very much.

You bet.

Your next question comes from the line of Doug Fischer from A.G. Edwards. Please proceed.

Thank you.

Good morning, Doug.

Good morning, Gary and the rest of the management team. Maybe you can talk a little bit about the peak demand that you had in July. Is that something that the purchase power costs, were they so high such that that will have a material impact on the quarter? The third quarter?

No, Doug. They won't. We did have to purchase some fairly high energy just for a couple hours. We did lose one unit of Colstrip for a little bit of time. So we were out in the market having to cover some of that, but it shouldn't be material.

It was about 50 megawatts, for just for a few hours on both days, but prices were well over $200.

Prices hit close to the soft cap, which is about $400 in the northwest at that point.

So, that's not part of your caution with regard to guidance for the utility for the year, in your response to Paul's question there.

No, because you can add up, it's about $20,000 an hour, Doug, and it was just a few hours each day, so it was immaterial.

It's more just generation, hydrogeneration falls off in the third quarter and we start using more thermals than hydro, which is something we traditionally do.

Maybe you can talk to us a little bit about the ERM in the third and fourth quarters. I know you touched on that, but maybe you can just elaborate. We've got a positive contribution for the six months and I know the fourth quarter's hard to predict, but just talk about what we should expect. Are you saying that that's likely, that $7 million is likely to erode over the next six months, materially?

Doug, this is Malyn and I think that is our forecast at this point in time, it really is too hard to tell where hydro is going to be, particularly in the fourth quarter. The fourth quarter will probably be the swing quarter for us. We will give some of it back in the third quarter. There's no doubt in my mind that that will happen. So, how much will we give back. I think it easily could be a few million dollars of the total and then the question will become what's hydro like in the fourth quarter? If it's normal, then I think it will probably stay at about that level. If it's above normal, we'll probably be back to the $7 million point and if it's below normal then we may eat some more in the fourth quarter, so it really is a pretty wide swing factor for us and that's one of the reasons that we're being real cautious on the guidance at this point.

Remind me what the guidance range for the utility assumed with regard to the ERM at the $1.00 and the $1.15.

At the $1.00 to $1.15, we were assuming but we had some changing factors from the time that we issued the original guidance to the update that we did in the first quarter, but the bottom line was we assumed that we would have some positive impact as a result of the ERM balance in the guidance

At the $1.15?

At the $1.15 level. Yes.

And did I understand correctly that the taxes other than income taxes at the utility is a pass-through dollar for dollar to the customer? Or was that just incorporated in the rate case so that there could be a mismatch.

Well, not all of it is a pass-through to the customer but the relative change in the taxes is a pass-through.

In both Washington and Idaho?

Yes, that's correct.

Yes.

Okay, thank you.

Your next question comes from the line of Steven Gambuzza from Longbow Capital. Please proceed.

Good morning.

Good morning.

Hi.

You mentioned that you brought down the deferral balance by $38 million year-to-date and if my memory serves, I think your original target was $30 million reduction for the year, assuming normal hydro so it seems like you are quite a bit ahead of schedule there. I was wondering if you expect that balance to build back up in the second half of the year or assuming normal weather going forward, normal hydro, that we might see a further reduction in that balance?

That's a very good question and it kind of relates a bit to the discussion that I was having with Doug. I would guess in the third quarter we might see the electric balance increase a little bit, simply because of the fact that we don't have a lot of hydro in that third quarter, but I would hope by the end of the fourth quarter that we will see it either flat or slightly improve in the quarter. We clearly have done a lot better than we were expecting to do already this year.

In terms of the kind of forward outlook, I realize that this is very difficult to predict going forward but in next year, assuming a continuation of normal hydro conditions, given the amortizations that are imbedded in your rate restructure, what type of further bring down in that balance should we expect. Just trying to get a sense for, if you have normal weather going forward, how long will it take you to bring that balance close to zero?

In a normal year, we would expect about $31 million in the Washington Electric side of the business. Now, we still have some gas deferral balances and those should also be dropping over time, such that there is probably another $10 plus million on the gas that we would hope to recover on an annual basis.

And then, you mentioned what your utility equity ratio was at the end of June. Would you mind just giving kind of a breakout in terms of if you have this number, this is the dollars of just your consolidated equity, how that splits out between Utility, Avista Energy and other Avista capital?

Well, this is Ann. The Utility equity is roughly $550, I think, or closer to $578 million and then the energy side is roughly $238 million.

And then other, I guess for IQ?

Yes.

That would be included in the $238?

IQ is roughly $2 million.

Okay. And now that you've had the Washington ERM proceeding behind you, what's on the regulatory calendar now in terms of the jurisdictions you operate in? Is there anything going on in Idaho or Oregon or are you pretty much clear for regulatory perspective, balance the year.

Our philosophy, we always do looks at each one of our jurisdiction, so right now we are in the process of evaluating both Oregon, Washington, and Idaho electric and gas and we'll make a determination sometime in the next month or two whether or not it warrants any further rate action, from a general rate perspective as well as a power cost perspective. We're also in the process of getting ready to file our purchase gas adjustment mechanisms and we're working on what those might look like for 2007. We need to file those sometime in the fall so we don't have a number yet. We expect to have some finalization of that. As you know, we do have a decoupling mechanism filing before the state of Washington and we continue to be hopeful that we can continue to work with staff there to get some resolution to that fairly soon. So, I think that about covers the regulatory.

And the purchase gas adjustment, that just relates to the gas utility.

Yes. That's the traditional way we adjust natural gas prices on a yearly basis. It's a pass-through, we don't make a profit on that, it's just really to reflect market prices.

Okay. And then, you mentioned in your release there was a small improvement in the Other segment and you mentioned that Advanced Manufacturing and Development was profitable. Just curious, as you look at the assets in the Other segment or across the entire portfolio of your businesses , if there are any assets that you believe would be non-core that you could sell or that might contribute to hitting your equity targets at the utility over the next two years?

The answer to that is yes, we are planning to monetize the MetalFx investment at some point in the next couple of years. We really have just been working to get it profitable so that we can, that we can sell that business.

And, approximately, what's the book value there?

Roughly $10 million.

Roughly that.

Okay. Thank you very much for your time.

Thank you.

Your next question comes from the line of Jim Bellessa from D. A. Davidson and Company. Please proceed.

Good morning.

Good morning, Jim.

Your balance sheet says $818 million of shareholder's equity and then I heard in response to the question how much you had in each component, each segment had of equity. It didn't total $818. I heard Utility equity at $578 million, Avista Energy at $238 million, Advantage IQ at $2 and the Other at $10. That's $728 million. Where am I short on the equity?

The Other segment actually has negative equity in total of $3 million.

Okay.

Let's go through the math again.

Utility was $578, Jim.

Yes.

Energy was $238.

The Energy segment.

That's $816.

That's $816 right there.

And then Advantage is $2.

And minus $3. That's okay, we're close. I just did my arithmetic wrong. Let's assume, like your close to normal hydro and July was five degrees the high temperature – the high temperature in your territory was five degrees above normal. The highs for the day were five degrees higher than normal. What would that normally do to you? Other than this unplanned purchase, what would hot weather do to you normally in July? Again, normal hydro.

Normally, you would expect that the warmer than normal weather would increase our earnings. That would be a positive thing for us.

I would just add to that, Jim, as you know, timing is - early in the month when we have a lot of hydro and July is always the swing month so by the end of July we tend to have less hydro and more thermal, so depending on the timing of how we run our generation it really is hard to predict, if that makes sense.

So to some extent it will depend on where we are in the deadband because right now we are clearly in the 90/10 sharing range and what ends up happening, as we have additional expenses, above the normal cost of production, then those dollars basically will reduce that 90/10 sharing until we get into the deadband. Then once we are in the deadband, then it's 50/50 for the first period of time, so I don't know how much of that -- I do know that our costs of production is more for July than what we would be recovering in rates. But we also should be having some good margin coming from those sales levels and the question really becomes doing the math and seeing where you are in the ERM. So, I believe that it will be a positive. I'm sure that it will, but I also think there will be some offset, which is why I'm cautioning.

Jim, I might answer the whole thing just a little bit different. In the sense that if we have all of our resources, sort of our native load on and we don't have any plant outages and the price of gas is in what we have forecasted in our rates, then it is a positive. The big factor nowadays is really the natural gas and whether or not the markets run in the hot weather because about 25% of our production is natural gas fired, so if natural gas runs high and we are our having to buy it to take and run those plants like when we lost the units we put our single cycles on, they're not very efficient, cost a lot more to run and we were buying higher gas prices - the gas prices were higher to take and run those, it drives your production costs above what's in rates, at which case, you actually have a negative effect with those higher loads and why that's conservation – that's why we went to our customers and said please back off your loads. They backed off for 30megawatts and that was actually a positive.

You had to crank up your single cycle. How about your – is it Coyote Springs II, did you run that for most of the month?

Sure, we had that plus the duct burner. We used pretty much all of our imbedded generation we have in the system.

Who is or what is DOI? Why would they be challenging you and why would this lead to a court proceeding?

Well, Jim, again, DOI is Department of Interior and, as you know, if you look around at hydro re-licensing across the country, certain federal agencies have mandatory – they have the opportunity to put mandatory conditions on utilities and hydro re-licensing proceedings and Department of Interior is one of those agencies, so outside of really any of the science or discovery, they can just make a determination what they feel the impact of Post Falls is on our re-licensing process and they can impose conditions on us. Fortunately for us in the Energy Policy Act of 2005, there is now a process for us to challenge those conditions. Prior to that, there really weren't any ramifications other than to go to court and fight it out. So, we expect in the fall of this year to be before the Department of Interior, the administrative law judge and use the proceeding that was passed in 2005 for us to try to modify those mandatory conditions.

Tell me how you get from an equity position at the utility of 34% and a year and a half from now being at 36%.

Well, I think that the retained earnings should be very helpful in doing that. Our cash flow has been positive, as we mentioned our debt actually has decreased fairly significantly this year, so we believe that if we have normal hydro conditions that we are lowering the deferral balances rather than adding to the deferral balances that we will get there basically through operating the company and paying out a fairly low amount in dividends in terms of the percentage of the total earnings of the company. And so, the forecast would be that we will be able to make those targets without having to tap the equity markets.

Your guidance for Avista Energy is $0.20 to $0.30 for year. And if I'm understanding what was said on the call, you have already achieved $0.12 of that for the first half?

That's correct.

Now, the reported figure, though, is only $0.01. What did you do to cause a marked-to-market decline? I thought gas had declined from March 31 to June 30? Gas prices. So what caused the marked-to-market to go the other, opposite direction from what I would have thought.

Jim, this is Dennis. You know, I thought the same thing intuitively with gas prices coming off during the quarter. I initially had the same thought you did but when you look at the actual winter time or Q1 ’07 price, that we have our storage against, it's only $0.03 difference so at the end of March to the the end of June, you are roughly the same price. So there has been a lot of volatility in between but that's not really driving it. There’s three components that are driving the difference, as I mentioned in the earlier -- and that is the storage, and it's primarily driven by new storage that we have in place that is representative of a difference in WACOG of additional gas volumes that we have a JP and some additional storage that we have in Montana that we have acquired to support our end-use business there and the market value of that gas and the periods in which it's expected to be withdrawn. So, that's driving about 30% of that difference, and then I went through in great length the tolling component and that's roughly 45% and then the rest of it is transportation and we have, as you know, long-term pipeline capacity contracts. The market value is dependent on price differentials between the injection and withdrawal points. The value of that pipeline capacity increased during the second quarter as the spreads widened. The contracts are not carried at market value but rather accounted for on an accrual basis but the hedges are marked-to-market, so that created part of that difference as well. That was, as I said, the rest of that $7.9 million total. So I know that's an awful longwinded answer, but those are the three major components that made up that difference.

To understand that I'll have to read the transcript.

Okay. You can give me a call, too.

Thanks for the response. What was WACOG? Was that an acronym that I heard?

Yes, that's the weighted average cost of gas in storage.

Thank you very much.

Your next question comes from the line of [Neil Steine from BKF Asset Management]. Please proceed.

Good morning. I had a few questions, if I could. First, could you break down the earnings at Avista Energy. I don't know if you can characterize some of them as asset management and some of them as speculative trading.

Yes, this is Dennis again. I get that question all the time. It's difficult to break it down because so much of what we do is managed as a single portfolio. However, when we look at our budgeted targets and historically how we perform, generally speaking the asset driven part of our business makes up 50 to 60 % of the margin. The term trading has been in the range historically of 40%.

Okay. So for that, what you would consider term trading or what you label term trading, that sort of has to be kind of recreated every quarter or every year in order to generate the level you've been generating? Where as the asset management you consider more ongoing or recurring.

That's correct. The asset management portion of our business if you look at it as a whole, has been profitable year over year, however it is still difficult to predict how much we'll make from that business. That also depends on market prices and volatility in the market. Because essentially your long optionality in a lot of those assets and how much value you can extract from there is a function of what happens in the market.

Gotcha. And what are your plans for the business? Are you going to stay in it or exit it? Is it worth anything to anyone else?

Neil, I think I've been fairly candid with the street over the past couple of years that it's probably not a business that is long term for our portfolio and certainly as we move forward here, we are looking harder at what strategies might be in place to exit this business, because we don't feel that – in fact, it's a good business and it serves a very needed function in the market place but it's one which creates us nothing but a lot of sleepless nights, I guess I would say. In the sense of how do you explain economically they're doing quite well and I said earlier I was satisfied with the results, but when you start having these – having to report on gap basis and whatever and trying to explain why, if you make a deal and put gas into storage and sell it forward, and then because the market moves and you have to report it differently on the storage then you do no your marked-to-market contract, it looks like a loss when it really isn't. It becomes very frustrating and I think as a management team, we've decided to look at alternatives going forward but we still support the business at this point but you can expect at some point in the future we probably will no longer be in the business.

I guess from the outside looking in, it's a very hard business to forecast earnings for and predict what's going to happen. I mean, how would you recommend that people forecast earnings for Avista Energy? Is it appropriate to put a growth rate on current earnings? Some sort of ROE calculation? How do you do that?

One of the reasons, Neil, that we've decided strategically it’s a difficult fit for us is that we really don’t have the balance sheet to maximize the potential that the business has. We end up every year, I think, not able to transact some business that actually would create some very significant value for us in the long term because of the balance sheet of the overall company. And, so, doing it on an ROE basis is tough because we, historically to date, we've earned around a 15% ROE since the inception of the business but the last couple of years it's been earning less than that this year also will probably, if we hit our targets, it will probably earn a 6 or a 7% return on us. That's not enough on a risk adjustment basis for this business. So, I'm confident that we're going to be able to hit our earnings guidance for this year. In the long term I would expect that someone who operates this business would be able to do a lot better than what that guidance is this year. If we were to keep it, we'd want to do better.

We'd have to do better.

We'd have to do better or it wouldn't make sense for us to stay in the business.

Internally, what type of methodologies do you guys use to forecast earnings for the business?

Well, we look at the recurring earnings, as we've talked about as a major component and we try to value the optionality against the forward curves as we see them and we also assume a component for the trading part of the business that they've historically been able to produce on a pretty consistent basis. We tried to be conservative this year because of the issues that we had last year and because of the fact that we've really tried, we've had to I think minimize some of the natural gas trading that's gone on there because of changes in the market place. We have been, I believe, appropriately conservative and we’re really very confident that we'll hit our target for this year. Looking ahead to next year, obviously we would hope that we will continue to do better and one of the ways that we're trying to do that is get more assets under management and the folks have been very successful with bringing in some new assets to manage as well as the Montana business is off to an excellent start that we just really got involved with this year, so I think they're doing some good things to grow that business but I think, as Gary said, long term it's not one that will be in our portfolio.

And, then, last question. Any quick thoughts on industry consolidation particularly in the northwest region?

Well, I would guess that there is some of that happening as you can read in the newspapers. That's a difficult issue because in order to make it work, you still have to have the support of your state commissions and your customers to really make that make sense. Do I think there will continue to be industry consolidation? Yes, I think there will continue to be industry consolidation. But I don't think it will be as wholesale as some of the people think it will.

Okay. Thanks very much.

Thank you, Neil.

Your final question comes from the line of Paul Ridzon of KeyBanc as a follow-up. Please proceed.

Do you track the deadband on a monthly basis and just kind of, if you do, where was it on July 31?

We do track it on a monthly basis, Paul, but we haven't closed the books for January, excuse me for July. January – where am I? We haven't closed the books for July yet so I don't know what the number is. But I'm glad you're still on because I'd like to answer your earlier question, if I might. You know, we had reported earnings of $0.91. If you add back the FAS 133 difference we talked about, that's $0.11 cents, that gets you to $1.02 and then I assume that you would back out the Enron as a one time because that wasn't in our estimate for the year. That's $0.04, so you'd be at $0.98. I think that's about where you were.

Is your guidance backing out Enron?

Well, we weren't assuming that we were going to get Enron when we did the original guidance.

And then how much are you dripping?

Nothing at this point in time.

I thought the comp was going to new issue.

Oh, I'm sorry. The comp is, and it's a pretty minimal number.

Less than 200,000, I think.

Do we have that? It's less than 200,000 shares.

Okay. Thank you.

You bet.

At this time I would now like to turn the call over to your host for any closing remarks.

I want to thank you all for joining us today. We certainly appreciate your interest in our company. As always, if you have any follow up questions. Please feel free to contact me at 509-495-2930. Again thank you for joining us and have a great day.

Thank you for your attendance at today's conference. This concludes the presentation. You may now disconnect. Have a wonderful day.