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AVA > SEC Filings for AVA > Form 10-Q on 7-Nov-2012All Recent SEC Filings

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Form 10-Q for AVISTA CORP


7-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Business Segments

We have two reportable business segments as follows:

Avista Utilities - an operating division of Avista Corp. that comprises our regulated utility operations. Avista Utilities generates, transmits and distributes electricity and distributes natural gas. The utility also engages in wholesale purchases and sales of electricity and natural gas.

Ecova - an indirect subsidiary of Avista Corp. (79.0 percent owned as of September 30, 2012) provides energy efficiency and cost management programs and services for multi-site customers and utilities throughout North America. Ecova's primary product lines include expense management services for utility and telecom needs as well as strategic energy management and efficiency services that include procurement, conservation, performance reporting, financial planning, facility optimization and continuous monitoring, and energy efficiency program management for commercial enterprises and utilities.

We have other businesses, including sheet metal fabrication, venture fund investments and real estate investments, Spokane Energy, as well as certain other operations of Avista Capital. These activities do not represent a reportable business segment and are conducted by various direct and indirect subsidiaries of Avista Corp., including AM&D, doing business as METALfx.

The following table presents net income (loss) attributable to Avista Corp. for each of our business segments (and the other businesses) for the three and nine months ended September 30 (dollars in thousands):

                                         Three months ended September 30,              Nine months ended September 30,
                                           2012                    2011                  2012                   2011
Avista Utilities                      $         7,660         $         7,582       $       65,157         $       68,733
Ecova                                             640                   3,467                  962                  7,016
Other                                          (2,514 )                  (347 )             (3,767 )                 (128 )

Net income attributable to Avista
Corporation                           $         5,786         $        10,702       $       62,352         $       75,621

Executive Level Summary

Overall

Net income attributable to Avista Corporation was $5.8 million for the three months ended September 30, 2012, a decrease from $10.7 million for the three months ended September 30, 2011. This was primarily due to a decrease in earnings at our unregulated subsidiaries (Ecova and Other). Net income at other subsidiaries decreased due to an impairment loss of $2.4 million pre-tax ($1.5 million after-tax) related to the impairment of our investment in a fuel cell business and the write-off of our investment in a solar energy company. Net income at Ecova decreased due in part to an increase in other operating expenses and depreciation and amortization related to intangibles recorded in connection with the acquisitions of Prenova and LPB. Additionally, organic growth in Ecova's expense and data management services was slower than expected and there was delayed implementation (transitioning of customers onto Ecova's systems) of new customers in Ecova's energy management services, which did not offset the increased costs as expected.

These losses in net income were partially offset by a slight increase at Avista Utilities primarily due to warmer weather during the third quarter that increased retail electric cooling loads and the implementation of general rate increases, offset by an increase in other operating expenses, depreciation and amortization, and taxes other than income taxes.

Net income attributable to Avista Corporation was $62.4 million for the nine months ended September 30, 2012, a decrease from $75.6 million for the nine months ended September 30, 2011. This was due to a decrease in earnings at Avista Utilities (primarily due to reduced retail loads during the first half of the year and an increase in other operating expenses, depreciation and amortization, and taxes other than income taxes, partially offset by the implementation of general rate increases). Net income at Ecova decreased due in part to increased costs associated with completing and integrating the acquisitions of Prenova and LPB, as well as an increase in depreciation and amortization. Additionally, revenue growth for the expense and data management services and energy management services at Ecova was not as high as expected and did not offset the increased costs. Other businesses incurred a net loss largely due to an impairment loss of $2.4 million pre-tax ($1.5 million after-tax) recognized during the third quarter of 2012.


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AVISTA CORPORATION

Avista Utilities

Avista Utilities is our most significant business segment. Our utility financial performance is dependent upon, among other things:

weather conditions,

regulatory decisions, allowing our utility to recover costs, including purchased power and fuel costs, on a timely basis, and to earn a reasonable return on investment,

the price of natural gas in the wholesale market, including the effect on the price of fuel for generation,

the price of electricity in the wholesale market, including the effects of weather conditions, natural gas prices and other factors affecting supply and demand, and

the ability to obtain financing through the issuance of debt and/or equity securities, which can be affected by various factors including our credit ratings, interest rates and other capital market conditions.

In our utility operations, we regularly review the need for rate changes in each jurisdiction to improve the recovery of costs and capital investments in our generation, transmission and distribution systems. General rate increases went into effect in Idaho on October 1, 2011, in Washington on January 1, 2012, and in Oregon effective March 15, 2011, June 1, 2011 and June 1, 2012. On April 2, 2012 we filed electric and natural gas general rate increase requests in Washington and on October 11, 2012 we filed electric and natural gas general rate increase requests in Idaho. On October 19, 2012, we entered into a settlement agreement in our Washington general rate cases that, if approved by the WUTC, would provide for electric and natural gas rate increases effective January 1, 2013 and January 1, 2014.

Our utility net income was $7.7 million for the three months ended September 30, 2012, an increase from $7.6 million for the three months ended September 30, 2011. The slight increase in utility earnings was primarily due to an increase in gross margin (operating revenues less resource costs) which was partially offset by increases in other operating expenses, depreciation and amortization, taxes other than income taxes, and interest expense. The increase in gross margin was primarily due to warmer weather that increased retail electric cooling loads, but was offset by reduced natural gas heating loads. Gross margin also benefited from general rate increases. Cooling degree days at Spokane were 37 percent above historical average for the third quarter of 2012 and were also 25 percent above the third quarter of 2011 which led to increased cooling loads. Other operating expenses increased for the third quarter of 2012 as compared to the third quarter of 2011 primarily due to increased pensions and other postretirement benefits, salaries, and general maintenance, partially offset by decreased outside service costs.

Our utility net income was $65.2 million for the nine months ended September 30, 2012, a decrease from $68.7 million for the nine months ended September 30, 2011. The decrease in utility earnings was primarily due to increases in other operating expenses, depreciation and amortization, taxes other than income taxes, and interest expense, partially offset by an increase in gross margin. The increase in gross margin was primarily due to warmer weather during the third quarter that increased retail electric cooling loads and general rate increases. This was partially offset by warmer weather during the heating season (primarily the first quarter) that reduced retail electric and natural gas loads. In addition, gross margin growth was limited in part by the continued weak economy and lower usage at certain industrial customers. Cooling degree days at Spokane were 24 percent above historical average for the first nine months of 2012 and were also 26 percent above the comparable period of 2011. Heating degree days at Spokane were close to historical average for the first nine months of 2012, but decreased 9 percent as compared to the first nine months of 2011. Other operating expenses increased for the nine months ended September 30, 2012 as compared to the nine months ended September 30, 2011 primarily due to increased pensions and other postretirement benefits, salaries, and general maintenance, partially offset by decreased electric maintenance costs (which included the regulatory deferral of $5.4 million of maintenance costs) and outside service costs.

We are making significant capital investments in generation, transmission and distribution systems to preserve and enhance service reliability for our customers and replace aging infrastructure. Utility capital expenditures were $178.4 million for the nine months ended September 30, 2012. We expect utility capital expenditures to be about $250 million for the full year of 2012. These estimates of capital expenditures are subject to continuing review and adjustment (see discussion under "Avista Utilities Capital Expenditures").

On October 22, 2012, we announced a voluntary severance incentive program to achieve Company-wide long-term saving of employment and related costs. All terminations under the voluntary severance incentive program are expected to be completed by December 31, 2012. The severance costs under this plan will be expensed in the fourth quarter of 2012 and cash payments will be made after December 31, 2012, but no later than February 1, 2013. The impact of this program cannot be reasonably estimated at this time.

Ecova

Ecova had net income attributable to Avista Corporation of $0.6 million for the three months ended September 30, 2012, a decrease from $3.5 million for the three months ended September 30, 2011. This decrease was due in part to increased operating expenses associated with the acquisitions of Prenova and LPB, as well as an increase of $1.5 million in depreciation and amortization due to intangibles recorded in connection with the acquisitions. In addition, Ecova's revenue growth in the expense and data management services was slower than expected and there was delayed implementation of new customers in Ecova's energy management services, which did not offset the increased costs as expected.


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AVISTA CORPORATION

Ecova had net income attributable to Avista Corporation of $1.0 million for the nine months ended September 30, 2012, a decrease from $7.0 million for the nine months ended September 30, 2011. Operating expenses increased due to the acquisitions of Prenova and LPB and depreciation and amortization increased $4.4 million due to intangibles recorded in connection with the acquisitions. In addition, Ecova's revenue growth in the expense and data management services was slower than expected and there was delayed implementation of new customers in Ecova's energy management services, which did not offset the increased costs as expected. This decrease was also due in part to $1.5 million in costs of completing the acquisitions and integrating Prenova and LPB during the first quarter of 2012.

On November 30, 2011, Ecova acquired Prenova, an Atlanta-based energy management company. The cash paid for the acquisition of Prenova of $35.6 million was funded primarily through borrowings under Ecova's committed credit agreement.

On January 31, 2012, Ecova acquired LPB, a Dallas-based energy management company. The cash paid for the acquisition of LPB of $50.6 million was funded by Ecova through $25.0 million of borrowings under its committed credit agreement, a $20.0 million equity infusion from existing shareholders (including Avista Capital and the other owners of Ecova), and available cash.

While these acquisitions have grown the overall cost structure for Ecova for the three and nine months ended September 30, 2012, they have also increased both operating revenues and Ecova's market share and will allow Ecova to offer its clients a broader range of services leading to potential future earnings growth once the acquisitions are fully integrated into Ecova's operations.

The acquisition of Cadence Network in July 2008 was funded with the issuance of Ecova common stock. Under the transaction agreement, the previous owners of Cadence Network had a right to have their shares of Ecova common stock redeemed by Ecova during July 2011 or July 2012 if their investment in Ecova was not liquidated through either an initial public offering or sale of the business to a third party. These redemption rights were not exercised and expired effective July 31, 2012 and were reclassified to equity.

The value of the remaining redeemable noncontrolling interests associated with stock options and other outstanding redeemable stock at September 30, 2012 decreased from $12.9 million at December 31, 2011 to $6.7 million. Options are valued at their maximum redemption amount which is equal to their intrinsic value (fair value less exercise price). During 2012, the estimated fair value of Ecova common stock has decreased such that it is closer to the exercise price of the options which reduces the overall value of the redeemable noncontrolling interests.

Consistent with recent years, Ecova plans to continue to grow organically and potentially through strategic acquisitions. Ecova's acquisitions have been funded through internally generated cash, borrowings under Ecova's credit facility and the most recent acquisition of LPB was funded in part through an equity infusion from existing shareholders. If Ecova's capital needs exceed its credit facility capacity, it will require additional equity infusion from existing shareholders and/or new funding sources.

We may seek to monetize all or part of our investment in Ecova in the future. The value of a potential monetization depends on future market conditions, growth of the business and other factors. This may provide access to public market capital and provide potential liquidity to Avista Corp. and the other owners of Ecova. There can be no assurance that such a transaction will be completed.

Other Businesses

The net loss for these operations was $2.5 million for the three months ended September 30, 2012 compared to a net loss of $0.3 million for the three months ended September 30, 2011. The net loss for these operations was $3.8 million for the nine months ended September 30, 2012 compared to a net loss of $0.1 million for the nine months ended September 30, 2011. The decline in results was primarily due to an impairment loss of $2.4 million pre-tax ($1.5 million after-tax) incurred during the third quarter of 2012 related to the impairment of our investment in a fuel cell business and the write-off of our investment in a solar energy company. Also, there were increased litigation costs for the remaining contracts and previous operations of Avista Energy.

Liquidity and Capital Resources

We need to access long-term capital markets from time to time to finance capital expenditures, repay maturing long-term debt and obtain additional working capital. Our ability to access capital on reasonable terms is subject to numerous factors, many of which, including market conditions, are beyond our control. If we were unable to obtain capital on reasonable terms, it could limit or eliminate our ability to finance capital expenditures and repay maturing long-term debt. Our liquidity needs could exceed our short-term credit availability and lead to defaults on various financing arrangements. We would also likely be prohibited from paying dividends on our common stock.

We have a committed line of credit with various financial institutions in the total amount of $400.0 million with an expiration date of February 2017. As of September 30, 2012, there were $82.0 million of cash borrowings and $26.8 million in letters of credit outstanding. As of September 30, 2012, we had $291.2 million of available liquidity under this line of credit.


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AVISTA CORPORATION

In July 2012, Ecova entered into a new five-year $125.0 million committed line of credit agreement with various financial institutions that replaced its $60.0 million committed line of credit agreement. As of September 30, 2012, Ecova had $58.0 million of borrowings outstanding under its committed line of credit agreement.

In June 2012, we entered into a bond purchase agreement with certain institutional investors in the private placement market for the purpose of issuing $80.0 million of 4.23 percent First Mortgage Bonds due in 2047. Issuance of the bonds will occur at closing in November 2012. Net total proceeds from the sale of the new bonds will be used to repay a portion of the borrowings outstanding under our $400.0 million committed line of credit and for general corporate purposes.

In May 2012, we cash settled interest rate swap contracts (notional amount of $75.0 million) and paid a total of $18.5 million. The interest rate swap contracts were settled in connection with the pricing of $80.0 million of First Mortgage Bonds as described above. Upon settlement of the interest rate swaps, the regulatory asset or liability (included as part of long-term debt) is amortized as a component of interest expense over the life of the forecasted interest payments.

In August 2012, we entered into two sales agency agreements under which we will sell shares of our common stock from time to time. In the third quarter of 2012, we sold 0.9 million shares for a total of $23.7 million (net of issuance costs). As of September 30, 2012, we had 1.8 million shares available to be issued under these agreements.

For the nine months ended September 30, 2012 we have issued $28.7 million (net of issuance costs) of common stock, including $23.7 million (net of issuance costs) under sales agency agreements. We do not expect to issue any further common stock under sales agency agreements during 2012. For 2013, we expect to issue up to $50 million of common stock in order to maintain our capital structure at an appropriate level for our business. After considering the issuances of long-term debt and common stock during 2012, we expect net cash flows from operating activities, together with cash available under our $400.0 million committed line of credit agreement, to provide adequate resources to fund:

capital expenditures,

dividends, and

other contractual commitments.

Avista Utilities - Regulatory Matters

General Rate Cases

We regularly review the need for electric and natural gas rate changes in each state in which we provide service. We will continue to file for rate adjustments to:

provide for recovery of operating costs and capital investments, and

provide the opportunity to improve our earned returns as allowed by regulators.

With regards to the timing and plans for future filings, the assessment of our need for rate relief and the development of rate case plans takes into consideration short-term and long-term needs, as well as specific factors that can affect the timing of rate filings. Such factors include, but are not limited to, in-service dates of major capital investments and the timing of changes in major revenue and expense items. We filed general rate cases in Washington in May 2011 (which was settled with new rates effective January 1, 2012) and in Idaho in July 2011 (which was settled with new rates effective October 1, 2011). We filed general rate cases in Washington in April 2012 and Idaho in October 2012.

Washington General Rate Cases

In December 2011, the Washington Utilities and Transportation Commission (WUTC) approved a settlement agreement in our electric and natural gas general rate cases filed in May 2011. As agreed to in the settlement agreement, base electric rates for our Washington customers increased by an average of 4.6 percent, which was designed to increase annual revenues by $20.0 million. Base natural gas rates for our Washington customers increased by an average of 2.4 percent, which was designed to increase annual revenues by $3.75 million. The new electric and natural gas rates became effective on January 1, 2012. No capital structure ratios or cost of capital components were specified in the settlement agreement.


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AVISTA CORPORATION

The settlement agreement provided for the deferral of certain generation plant maintenance costs. In order to address the variability in year-to-year maintenance costs, beginning in 2011, we deferred certain changes in maintenance costs related to our Coyote Springs 2 natural gas-fired generation plant and our 15 percent ownership interest in Units 3&4 of the Colstrip generation plant. For 2011 and 2012 the Company will compare actual, non-fuel, maintenance expenses for the Coyote Springs 2 and Colstrip plants with the amount of baseline maintenance expenses used to establish base retail rates, and defer the difference. This deferral was to occur annually, with no carrying charge, with deferred costs being amortized over a four-year period, beginning in the year following the period costs are deferred. The amount of expense to be requested for recovery in future general rate cases would be the actual maintenance expense recorded in the test period, less any amount deferred during the test period, plus the amortization of previously deferred costs. Total net deferred costs under this mechanism in Washington were a regulatory asset of $3.3 million as of September 30, 2012 compared to a regulatory liability of $0.5 million as of December 31, 2011. As part of the settlement agreement in October 2012 to our latest general rate case discussed in further detail below, the parties have agreed that the maintenance cost deferral mechanism on these generation plants would terminate on December 31, 2012, with the four-year amortization of the 2011 and 2012 deferrals to conclude in 2015 and 2016, respectively.

On October 19, 2012 Avista Corp. and certain other parties in the Company's electric and natural gas rate case filings filed a settlement agreement with the WUTC that, if approved by the WUTC, would conclude the general rate requests filed on April 2, 2012. New rates would take effect on January 1, 2013 and January 1, 2014. The WUTC approved a settlement procedural schedule for hearings that provides the WUTC with the opportunity to address the settlement prior to the settlement's proposed implementation date of January 1, 2013. The parties' request to approve the settlement is not binding on the WUTC. Parties to the settlement agreement include the staff of the WUTC, Northwest Industrial Gas Users, Industrial Customers of Northwest Utilities and The Energy Project, a low-income customer advocacy group. The Public Counsel Section of the Washington Office of the Attorney General and the Northwest Energy Coalition did not join in the settlement agreement.

The settlement proposes that, effective January 1, 2013, we would increase base rates for our Washington electric customers by an overall 3.0 percent (designed to increase annual revenues by $13.6 million), and for our Washington natural gas customers by an overall 3.6 percent (designed to increase annual revenues by $5.3 million). The settling parties agree that a one-year credit of $4.4 million would be returned to electric customers from the existing Energy Recovery Mechanism (ERM) deferral balance so the net average electric rate increase impact to our customers in 2013 would be 2.0 percent. The credit to customers from the ERM balance would not impact our earnings.

The settlement also proposes that, effective January 1, 2014, we would increase base rates for our Washington electric customers by an overall 3.0 percent (designed to increase annual revenues by $14.0 million), and for our Washington natural gas customers by an overall 0.9 percent (designed to increase annual revenues by $1.4 million). The settling parties agree that a one-year credit of $9.0 million would be returned to electric customers from the then-existing ERM deferral balance, if such funds are available, so the net average electric rate increase impact to our customers effective January 1, 2014 would be 2.0 percent.

The settlement agreement also states that we would not file a general rate case in Washington that would cause an increase in base retail rates before January 1, 2015. We could, however, make a filing prior to January 2015, but new rates resulting from the filing would not take effect prior to January 1, 2015. This does not preclude us from filing annual rate adjustments such as the PGA.

Our original request filed with the WUTC in April 2012 included a base electric rate increase of 9.0 percent to produce $41.0 million in additional electric revenue. The original filing also requested a $10.1 million, or 7.0 percent, increase in natural gas revenues. The electric and natural gas filings reflected a proposed rate of return on rate base of 8.25 percent with a common equity ratio of 48.4 percent and a 10.9 percent return on equity. The settlement agreement provides for an authorized return on equity of 9.8 percent and an equity ratio of 47 percent, resulting in an overall return on rate base of 7.64 percent.

As part of the general rate case, we asked the WUTC to address the delay between the time when costs are incurred and the time when new rates are reviewed and approved by the WUTC and go into effect. This delay is referred to as regulatory lag. We contracted with a consultant to develop an attrition study to determine the annual revenue short-fall related to regulatory lag. We proposed an attrition adjustment in this general rate case filing, based on the attrition study, which was designed to eliminate the annual revenue short-fall related to regulatory lag. Although a specific attrition adjustment was not identified or agreed to in the settlement agreement, the results of the settlement agreement, if approved by the Commission, would represent incremental improvement in addressing regulatory lag, and would provide Avista the opportunity to improve its earned return in Washington in 2013 and 2014, as compared to prior years.

Idaho General Rate Cases

In September 2011, the IPUC approved a settlement agreement in our general rate case filed in July 2011. The new electric and natural gas rates became effective on October 1, 2011. As agreed to in the settlement agreement, base electric rates for our Idaho customers increased by an average of 1.1 percent, which is designed to increase annual revenues by $2.8 million. Base natural gas rates for our Idaho customers increased by an average of 1.6 percent, which is designed to increase annual revenues by $1.1 million.

As part of the settlement agreement, we agreed not to file a general rate case seeking a change in base electric or natural gas rates effective prior to April 1, 2013. This does not preclude us from filing annual rate adjustments such as the PCA and the PGA.


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AVISTA CORPORATION

The settlement agreement also provides for the deferral of certain generation . . .

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