AVA

Avista Corporation 10-Q Summary: Quarter Ended March 31, 2007

Business Context and Reporting Period

This is a Quarterly Report (Form 10-Q) for Avista Corporation, a diversified energy company engaged in regulated utility operations (electricity and natural gas) and non-utility energy marketing and trading. The report covers the three-month period ended March 31, 2007. A significant strategic development during this period was the agreement to sell substantially all contracts and operations of its non-utility energy trading subsidiary, Avista Energy, to Coral Energy Holding, L.P. (a Shell subsidiary).

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Total operating revenues decreased $40.0 million (8.0%) year-over-year. This was driven primarily by a $32.1 million drop in non-utility energy marketing revenues and a $9.0 million decrease in utility revenues due to lower wholesale electric sales.
• Profitability Drop: Net income fell 55% to $14.1 million. The primary driver was a net loss of $7.6 million in the Energy Marketing and Resource Management segment (Avista Energy), compared to a $5.0 million profit in the prior year. This loss was attributed to underperformance in power trading and unrealized losses on derivative instruments.
• Utility Segment Performance: Avista Utilities net income decreased to $19.9 million from $26.2 million. This was caused by a $7.4 million reduction in gross margin, largely due to higher electric resource costs exceeding base retail rates (resulting in a $3.2 million expense under the Energy Recovery Mechanism) compared to a benefit in the prior year.
• Balance Sheet Shifts: Assets held for sale increased significantly to $601.0 million, reflecting the classification of Avista Energy assets pending the sale to Coral Energy. Total debt decreased slightly by $15.8 million.

Guidance, Outlook, and Risks

• Avista Energy Sale: The company expects to close the sale of Avista Energy in late Q2 or early Q3 2007. Proceeds are estimated at approximately $175 million, which management plans to redeploy to reduce debt and fund capital assets in regulated utility operations.
• Capital Expenditures: Utility capital expenditures for 2007 are forecast at $180 million, focusing on transmission enhancements and generation upgrades.
• Rate Cases: A general rate case was filed in Washington in April 2007 requesting an average 15.9% increase in electric rates and 2.3% in natural gas rates. Approval is expected to take up to 11 months, with potential effectiveness in 2008.
• Regulatory Risks: The company faces ongoing legal and regulatory proceedings related to western energy markets (2000-2001), including refund proceedings in California and the Pacific Northwest. Management believes reserves are adequate and does not expect a material adverse effect.
• Environmental Compliance: New regulations regarding greenhouse gas emissions and mercury controls (particularly in Washington and Montana) may increase capital and operating costs for thermal generation facilities.

Investor Verification Checklist

• Transaction Closing: Verify the closing date and final proceeds of the Avista Energy sale to Coral Energy, as this is critical for debt reduction plans.
• Rate Case Outcome: Monitor the Washington Utilities and Transportation Commission (WUTC) decision on the April 2007 rate case, as it impacts future revenue recovery.
• Derivative Valuation: Review the impact of unrealized losses on energy commodity derivatives, which significantly impacted Q1 2007 earnings.
• Hydroelectric Forecast: Track precipitation and snowpack levels, as hydroelectric generation forecasts (currently normal for 2007) directly affect resource costs and cash flow.
• Legal Contingencies: Monitor developments in the California Refund Proceeding and other western energy market litigation to assess potential liability changes.