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Executives

Jason Lang - IR Manager

Scott Morris - Chairman, President & CEO

Mark Thies - SVP & CFO

Dennis Vermillion - SVP & President, Avista Utilities

Kelly Norwood - VP State and Federal Regulation, Avista Utilities

Analysts

Jim Bellessa - D.A. Davidson & Company

Jennifer Sireklove - McAdams Wright Ragen

Mike Hann - Bryn Mawr Capital

Paul Ridzon - KeyBanc

Eric Beaumont - Copia Capital

Avista Corp. (AVA) Q3 2010 Earnings Call October 28, 2010 10:30 AM ET

Operator

Good day ladies and gentlemen and welcome to the Q3 2010 Avista Corporation earnings conference call. My name is Keith and I will be your operator for today. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. (Operator Instructions). As a reminder, today’s conference is being recorded for replay purposes.

I would now like to turn the conference over to your host for today Mr. Jason Lang, Investor Relations Manager. Please proceed sir.

Jason Lang

Thanks, Keith. Good morning everyone. Welcome to Avista’s third quarter 2010 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. Chairman of the Board, President and CEO, Scott Morris; Senior Vice President and CFO, Mark Thies; Senior Vice President and the President of Avista Utilities, Dennis Vermillion; Vice President of Finance, Jason Thackston; Vice President, State and Federal Regulations, Kelly Norwood; and the Vice President, Controller and Principal Accounting Officer, Christy Burmeister-Smith.

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, please refer to our Form 10-K for 2009 and Form 10-Q for the second quarter of 2010 which are available on our website.

To begin this presentation I’d like to recap the financial results presented in today’s press release. For the third quarter of 2010, our consolidated earnings were $0.22 per diluted share compared to $0.15 per diluted share for the third quarter of 2009.

On a year-to-date basis our consolidated earnings were $1.20 per diluted share for 2010 compared to $1.18 for 2009.

Now, I will turn the discussion to Scott Morris.

Scott Morris

Well thank you, Jason and good morning everyone. We had a strong third quarter and our outlook continues to improve for the full year of 2010 particularly with respect to our utility earnings. We are forecasting a lower power supply cost than the amount included in base rates and we have continued to manage our operating expenses.

The improvement in the second and third quarters has partially offset a very challenging first quarter due to one of the warmest Januarys to March periods on record.

As such, we are confirming our 2010 earnings guidance and this is an improvement from our report at the end of the second quarter when we expect it to be in the lower half of the range. We continue to execute on our regulatory strategy to increase recovery of operating cost and capital investments in our utility business.

In September, we found a natural gas general rate case in Oregon effective on October 1, new electric and natural gas rates went into effect in Idaho with approval of our general rate case settlement by the Idaho Commission. And in August we reached a settlement in the Washington general rate case. The settlement is designed to increase base electric revenues by $29.5 million and base natural gas revenues by $4.6 million.

The settlement is based on overall rate of return of 7.9% with a common equity ratio of 46.5% and a 10.2% return on equity. If approved by the Washington commission new rates would become effective December 1. And we believe that both settlements provide a fair and reasonable outcome for customers and shareholders.

Our economy continues to be challenged. Employment levels throughout our service area remained well below trend after significant and persistent cut backs in the construction and forest product sectors. The mining and manufacturing sectors are above the recession lows but they remain well below pre-recession levels.

The job market Spokane and Coeur d’Alene slowed later in the cycles and in the United States as a whole, well network has been more inline with the nation. Unemployment rates continue to remain high; the latest data for September indicates an 8.2% unemployment in Spokane and 9.3% in Coeur d’Alene and 11.4% in Medford compared to the national average of 9.6%.

The housing markets in Coeur d’Alene and Medford have above national average for closure rates and the majority of our housing market is in the Spokane County and therefore closure rates are well below the national average.

We have revised downward our economic outlook for 2011 and as such we expect lower load growth in our residential and commercial sectors. This has reflected in our 2011 guidance. We expect employment in Medford’s Spokane and Coeur d’Alene to be stable for the next 12 to 18 months with a modest recovery to trend beginning in 2011.

This is a later economic recovery that we previously expected. We are committed to continuing our investment in our utility infrastructure with a focus on increasing capacity and maintaining or improving reliability.

Utility CapEx was a $138 million for the first nine months of the year, and we expect capital expenditures to be about $210 million for 2010 excluding cost for our projects associated with stimulus funding. We continue to be very pleased with the results Advantage IQ. The earnings contribution from this business has grown by over 50% in 2010 as compared to 2009. Advantage IQ is continuing to execute on its strategy to extend the business from a focus on expense management to delivery of energy management services to both the utility and commercial and industrial marketplace.

We are initiating our 2011 earnings guidance which shows improvement over expected 2010 results. And while we expect to return to normal weather conditions and the impact of general rate cases, our earnings guidance will be limited by weak economic conditions continued delay in the recovery of our cost and increased operating and maintenance expenses.

So now I am going to turn this presentation over to Mark Thies and Mark is going to provide you with details on the performance of our businesses, liquidity, financing activities and detailed earning guidance.

Mark Thies

Thank you, Scott and good morning everyone. Thanks for joining us this morning. For the third quarter as Scott said Avista had a very strong third quarter. Avista Utilities contributed $0.16 per diluted share compared to $0.13 per diluted share for the third quarter of last year. This increase was primarily due to an increase in gross margin, partially offset by increases in interest expense, other operating expenses, depreciation and amortization and income taxes.

On a year-to-date basis, our utility operations contributed a $1.10 for diluted share compared to a $1.15 in 2009. The decrease was primarily due to increase in interest expense, operating expenses and appreciation partially offset by increases in gross margin.

During 2009, we carried relatively high balances under our committed line of credit at very low interest rates. We are refinancing these borrowings last September with the issuance of first mortgage bonds and historically favorable long-term interest rate. This increased interest expense in 2010 as compared to prior year.

Adjustments associated with reconciling our federal tax return for 2009 and prior year income tax returns were resulted in a decreased interest income tax expense of $1.7 million for 2010. In September of 2009, we recorded adjustments related to our 2008 federal income tax returns that had a favorable impact to income of $3.2 million.

In Washington rate case settlement all parties have agreed that deferred net cost associated with the Lancaster plant will be limited to $6.8 million for 2010 and there will not be any deferrals under the energy recovery mechanism for 2010. The company will either absorb all of the cost or receive all of the benefit from the amount of power supply costs in excess level or below the level in retail rates.

As of the end of September, our power supply cost were approximately $1million below the level in retail rates. We expect the effects of the settlement for the Lancaster plant deferrals and the energy recovery mechanism to come close to offsetting each other.

Advantage IQ’s net income attributable to Avista for the third quarter and year-to-date increased as compared to last year with an earnings contribution of $0.05 per diluted share for the quarter and $0.10 per diluted share on year-to-date basis.

The increase was primarily due to the acquisition of Ecos last August. In addition, Advantage IQ had a business and occupation tax refund in the third quarter of 2010. Advantage’s earnings continue to be moderate by low short-term interest rates and slow organic growth due to the economic conditions of the country.

Advantage IQ’s revenues for the first nine months increased 36% as compared to last year and totaled $74.7 million. The increase in revenues was primarily due to the third quarter acquisition of Ecos.

In our other businesses, we had a $0.01 per share net income from those businesses in the third quarter and on a year-to-date basis those are breakeven. Liquidity at the end of September, we had a combined $335 million of available liquidity under our $320 million committed line of credit, our $75 million committed line of credit and our $50 million accounts receivable financing facility.

For the fourth quarter of 2010, we are planning subject to market conditions to cause the redemption of $83.7 million of our pollution control bonds that we purchased in 2008 and in 2009 and refund these with new bond issues.

As a holder of the bonds, we would receive all redemption proceeds. We expect to issue up to $45 million of common stock in 2010 and we also expect to issue up to $25 million of common stock in 2011 to maintain our capital structure in an appropriate level. We are party to a sales agency agreement in which we sell shares of our common stock from time-to-time.

In 2010 we settled a total of 1.6 million shares for a total of $33.3 million through September. As of the end of September, we had 1.5 million shares available to be issued under this agreement. As Scott mentioned, we are confirming our 2010 consolidated guidance to be in the range of a $1.55 to $1.75 per share. This is an improvement from our report at the end of the second quarter in which we expect to be in the lower half of this range.

We expect a contribution from Avista Utilities to be in the range of $1.45 to $1.60 per diluted share for 2010. Our outlook for Avista Utilities assumes among other variables normal precipitation and temperatures for the remainder of the year as well as the implementation of the rate case settlement on December 1 in Washington.

We continue to expect Advantage IQ to contribute in the range of $0.10 to $0.13 per diluted share for 2010 and although we are not changing our 2010 guidance for the other businesses of between a breakeven and a contribution of $0.02 we may experience a slight loss.

And now I would like to talk about the initiation of our 2011 guidance for consolidated earnings. And our range for those are $1.60 to $1.80 per diluted share. We expect Avista Utilities to contribute in the range of $1.47 to $1.62 per diluted share for 2011. as compared to 2010, we expect our 2011 utility earnings to be positively impacted by a return to normal weather conditions and the effects of general rate increases.

We expect our 2011 utility earnings to be negatively impacted by slow low growth due to the economy as Scott mentioned earlier continued delay in the recovery of operating expenses and capital investments as well as increased operating and maintenance cost.

These increases include scheduled generation plant major maintenance expense and pension and medical cost. Our range for Avista Utilities encompasses expected variability in power supply cost and the application to the energy recovery mechanism to that power supply cost variability. The midpoint of our guidance range does not include any benefit or expense under the ERM.

We are currently expecting a benefit under the ERM in 2011within the 90% customer, 10% company sharing band. It is important to note that the forecast of our position in the ERM can vary significantly due to a variety of factors including the level of hydroelectric generation and retail loads as well as changes in purchase power and natural gas fuel prices.

Our outlook for Avista Utilities also assumes among other variables normal precipitation and temperature in hydroelectric generation as well as the implementation of the Washington rate case settlement in December. We expect Advantage IQ to contribute in the range of $0.13 to $0.16 per share for 2011 and other businesses to be between a breakeven a contribution of $0.02 per share.

I will now turn the conference call back over to Jason.

Jason Lang

Thanks Mark. And now we would like to open this call up for questions.

Question-and-Answer Session

Operator

Ladies and gentlemen (Operator Instructions). Your first question is from the line of James Bellessa with D.A. Davidson & Company. Please proceed.

Jim Bellessa - D.A. Davidson & Company

How much was this Advantage IQ business and occupation tax refund?

Mark Thies

That was less than a penny, Jim.

Jim Bellessa - D.A. Davidson & Company

And then secondly, you talk about, for next year, some scheduled generation plant maintenance, are there any key plants that are going to be out that you can outline for us now?

Dennis Vermillion

Jim, this is Dennis. The plant that we are referencing here is one of our Colstrip units in Eastern Montana. It will be down in Q2 for plant or a schedule maintenance its nothing out of the ordinary which is periodic maintenance needs to be done.

Mark Thies

That was out in June 2010.

Jim Bellessa - D.A. Davidson & Company

The improvement in earnings for the utility in ‘11 versus ‘10 is not very great, is this because you are compromising in your rate cases?

Mark Thies

No, I don’t believe so at all. Jim, I think what’s occurred is as Scott mentioned earlier when he was talking about the economy has slow down. We had anticipated more growth in the economy and our economist looked at it and said previously we had expected that economic recovery to begin later in 2010 and continue through 2011. We now don’t expect that to occur until either 2011 or into 2012.

So, part of that economic slowdown has sort of this week continue to experience lag as we continue to have an increase in cost and we continue to deploy capital. We believe that the settlements that we reached with both the Idaho Commission and then the pending settlement in front of Washington Commission is reasonable and fair to both shareholders and customers.

Jim Bellessa - D.A. Davidson & Company

And the Oregon case, when should that be settled and you might benefit from a rate increase?

Kelly Norwood

Jim, this is Kelly. That case was just filed and we have a schedule. In the past, we have settled those cases obviously worked toward that if the opportunity is there but the schedule would carry us out into the July timeframe if it goes that long. But we would expect some margin in 2011 from that case.

Operator

Your next question is from the line of Jennifer Sireklove with McAdams Wright Ragen. Please proceed.

Jennifer Sireklove - McAdams Wright Ragen

I just want to make sure that I understood your impact on your 2011 guidance. So, if you say that you’re expecting a benefit in that 90% range, that would mean that your power supply costs are expected to be greater than $10 million or more than $10 million above what’s already baked into your rates?

Mark Thies

No, the other way around. Less than what’s it’s include in our rates. Again there is a lot of a factor that can impact that but that’s where our current forecast is.

Jennifer Sireklove - McAdams Wright Ragen

And so, that’s actually my next question, I mean to what extent is that based on power and fuel costs that you have already locked in or your expectations of that, how those will evolve going forward?

Mark Thies

It’s a combination we have. We hedge overtime some portion of our power supply cost but we also leave some portion of those costs open as we move through the year and through the years as we go on an ongoing basis, we look at it in a three year cycle. So, part of that is it has some existing hedges part of where we continue to leave open and some of that we will continue to look at in and add to our amounts hedges we through the year.

The other part of it is really based on hydro and our hydroelectric forecasts expect normal perception and we are just in October right now. So, we don’t know where that will come out but the impact of hydro also impacts our power supply cost.

Jennifer Sireklove - McAdams Wright Ragen

Right. So, certainly these things are evolving. I was just trying to get a sense of the magnitude of what is known at this point and what is variable in terms of how this cost will evolve in 2011?

Mark Thies

They don’t break that down by any percentages of as to what’s known or what’s variable. There is a good portion of it that is variable and a lot of that is if you look at our hydro generation I mean that’s all variable.

Jennifer Sireklove - McAdams Wright Ragen

Certainly. And so, that would be comparable to years past. There’s no more that is known at this point than any year in the past?

Mark Thies

No, correct. I believe that’s accurate.

Operator

Your next question is from the line of Mike Hann with Bryn Mawr Capital. Please proceed.

Mike Hann - Bryn Mawr Capital

I just wanted to confirm, which settlements are in your guidance for the remainder of 2010 and 2011. I know you haven’t reached or the settlement hasn’t been approved in Washington. Is the settlement as it stands right now, is that in your guidance?

Kelly Norwood

This is Kelly. The Idaho settlement was approved when rates were effective October 1. So that’s unknown. The Washington settlements that you just talked about the proposal is for the rates to be effective December 1. And so the assumption in the guidance is that the commission works and the commission will approve that and rates would be effective December 1. And obviously the commission has to make that decision that our expectation whether that settlement would be approved and rates to be effective December 1.

Mike Hann - Bryn Mawr Capital

So then it’s also as the settlement stands now in the guidance for next year?

Mark Thies

Yes.

Kelly Norwood

Yes.

Mike Hann - Bryn Mawr Capital

And then anything that would come up from Oregon, of course, that is not in your guidance?

Kelly Norwood

Not for 2010. But there is some in 2011 reflected.

Mike Hann - Bryn Mawr Capital

Okay. And how much was the benefit, just a couple of follow-ups, how much in earnings came from the Ecos year-over-year and the quarter. You said less than a penny from the tax refund but I just wanted to breakout kind of the core Advantage IQ business performance?

Mark Thies

We don’t separate those performances included in Advantage IQ’s is Ecos and we have not historically separated that out. They are large you know a large percentage of the revenue growth, our growth is primarily due to that acquisition but we don’t split that out.

Mike Hann - Bryn Mawr Capital

Okay, and then do you have any comps I guess that I was pretty interested in the way you were able to offset the lower natural gas business revenues with the wholesale operations. So, how much of those wholesale operations are ongoing in nature and in other words if sales rebound again and I would assume a lot of that will go away?

Mark Thies

What happens is we purchase gas and we have gas in storage and we plan for an expected load amount on the natural gas side to the extend we had warmer weather and didn’t receive that additional load we were able to sell that natural gas that we had planned for our retail load in the wholesale market. We don’t really have a wholesale or non-regulated operations, that’s all part of our utility operations to the extend that we have contracted gas; we just have to go and sell that gas.

Mike Hann - Bryn Mawr Capital

Okay. And all the optimization opportunities occur within the utility as well?

Mark Thies

Yes and that all goes back to the customers through the PGA.

Mike Hann - Bryn Mawr Capital

Okay. And then the only other thing I didn’t understand in the release was the thermal generation resource optimization. The sales of fuel increased due to an increase in thermal generation resource optimization in 2010. Can you characterize that a little bit?

Mark Thies

What happens with that is we purchased fuel to fuel either Coyote Springs or Lancaster into the extend we don’t run those plants and we have that fuel, we don’t run those plants because load is down. It’s very similar to the natural gas operations where we turn around and sell that natural gas in the market and again to help offset the overall optimize that plant to improve our recovery for our customers.

Operator

Your question is from the line of Paul Ridzon with KeyBanc. Please proceed.

Paul Ridzon - KeyBanc

How much of your $45 million did you say you sold year-to-date?

Kelly Norwood

$33.33 million amount of equity that we have issued through September, Paul.

Paul Ridzon - KeyBanc

In your Washington settlement, what’s the embedded price of natural gas in there?

Kelly Norwood

$5.13.

Paul Ridzon - KeyBanc

Is that one of the things that leads you to think you’re going to be on the right side of the ERM in 2011?

Kelly Norwood

Yes. As you look at prices going forward what we have seen as far as a decline in prices. But as you know that can change going forward.

Operator

Your next question is from the line of Eric Beaumont with Copia Capital. Please proceed.

Eric Beaumont - Copia Capital

Paul asked my one question on the embedded gas price, the other is what’s kind of the expectation for the ERM for the remainder of the year?

Mark Thies

Again with the proposed settlements we have no deferrals. So what we have said when we announced the settlement was we limited and Kelly can add to this, we limited the amount of our deferrals under Lancaster to $6.8 million and then we were able to keep the difference of having no deferrals under the ERM. And so we anticipate that those items will largely offset this year and so then on an expected basis if its and we expect to be in the 910 sharing bands under the historic ERM. So that would allow us to offset the cost related to Lancaster.

Eric Beaumont - Copia Capital

And again I just want to make sure I’m not confusing 2010 and 2011, so the deferrals, you have the piece for 2010 and then 2011 you also have a piece that you’ll be able to use from the Langley?

Mark Thies

No. The Lancaster has done at that, that’s just done in rate and we will earn a return on that but then we return to our historic energy recover mechanism in ‘11 and we expect as we said to be in the benefit position of the 90% customer, 10% company band at this point in time.

Eric Beaumont - Copia Capital

And there’s going to be somewhat a balance there, obviously the gas price gives you some headroom but the expected weaker economic conditions would give you some of that either natural gas or generation fuel optimization based on the load you’re looking at and if that weren’t to be there then you would likely have better utility results that are somewhat of a balancing mechanism one way or the other with regards to that. Is that accurate?

Mark Thies

Not necessarily, we have our forecasted load in there and we have the energy recover mechanism as we have it. So to the extend we get an improvement in load due to for example, a colder winter and we have higher loads we would expect to see improved earnings related to that and that may or may not have a significant impact on the energy recovery mechanism.

We will know where the gas prices will go. We could have an improvement in our loads. We could have a negative as well but we could have an improvement due to weather or a faster improving economy.

Eric Beaumont - Copia Capital

No, I understood, Mark. I just want to make sure, obviously with the expected ERM benefit next year, the headline and you obviously can’t project what may or may not happen but obviously it looks like a reasonable adder to the guidance that you put out there and I’m just trying to make sure that, without really seeing gas price go or hydro just being horrendous that there’s somewhat of a balancing if you end up with or you could just be one side as a positive. I’m just trying to characterize the risks or benefits to that piece?

Mark Thies

As you mentioned hydro could move or gas prices could move, we don’t control either of those. But the other side just to be clear of it that is independent, largely independent of our load which is more based on the weather and the temperature. So that could go up or down and we still could have the same expectations with respect to the energy recovery mechanism.

Operator

(Operator Instructions). And you have a follow-up from the line of James Bellessa with D.A. Davidson & Company. Please proceed.

Jim Bellessa - D.A. Davidson & Company

Yes, I would like to hone in on Advantage IQ for a second. Your guidance calls for this year the earnings to be from $0.10 to $0.13 a share. You have already reported $0.10 for the nine months, so, you’re implying that the fourth quarter might be from zero to $0.03.

You have just reported a quarter of $0.05 but we were told that maybe up to $0.01 was from this refund. So, you have a $0.04 quarter. Why do you think that the earnings from Advantage IQ will be down in the fourth quarter from the run rate adjusted in the third quarter?

Scott Morris

Jim, primarily its because of a lot of the work that Ecos does is work for utilities and doing energy efficiency programs for utilities across the country and Ecos is able to execute and do a lot of that work, I think a little bit earlier than we expected. So, while Ecos has been able to execute and put a lot of that work in, we don’t expect them to continue with the same pace until the fourth quarter.

They did some of the work early so little bit with Ecos that might be timing. But that being said, we are very pleased with the performance, its transition away from just an expense management company into an energy management company, we are seeing some really nice growth in our consulting services business.

Ecos and working with utilities has been a wonderful addition to the business and again without having the flow that we normally have this business is performing quite well and the management team we put in a year ago is doing a fantastic job of executing on the strategy.

Operator

There are no other questions at this time. So I would like to turn the call back over to Mr. Jason Lang for closing comments.

Jason Lang

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

Operator

Ladies and gentlemen that concludes today’s conference. Thank you for your participation. You may now disconnect. Everyone have a great day.

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