Edgar Filing: AVISTA CORP

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FORM 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington D.C. 20549

FORM 10-Q

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2012

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number 1-3701

AVISTA CORPORATION

(Exact name of registrant as specified in its charter)

Washington

91-0462470

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)


1411 East Mission Avenue, Spokane, Washington		99202-2600
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: 509-489-0500

Web site: http://www.avistacorp.com

None

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act): Yes ¨ No x

As of October 31, 2012, 59,763,977 shares of Registrant’s Common Stock, no par value (the only class of common stock), were outstanding.

AVISTA CORPORATION

Index


			Page No.
Part I.	Financial Information:

	Item 1.	Condensed Consolidated Financial Statements

	Condensed Consolidated Statements of Income - Three Months Ended September 30, 2012 and 2011			5

	Condensed Consolidated Statements of Income - Nine Months Ended September 30, 2012 and 2011			6

	Condensed Consolidated Statements of Comprehensive Income - Three and Nine Months Ended September 30, 2012 and 2011			7

	Condensed Consolidated Balance Sheets - September 30, 2012 and December 31, 2011			8

	Condensed Consolidated Statements of Cash Flows - Nine Months Ended September 30, 2012 and 2011			10

	Condensed Consolidated Statements of Equity and Redeemable Noncontrolling Interests - Nine Months Ended September 30, 2012 and 2011			11

	Notes to Condensed Consolidated Financial Statements			12

	Report of Independent Registered Public Accounting Firm			36

	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		37

	Item 3.	Quantitative and Qualitative Disclosures about Market Risk		63

	Item 4.	Controls and Procedures		64

Part II.	Other Information:

	Item 1.	Legal Proceedings		64

	Item 1A.	Risk Factors		64

	Item 4.	Mine Safety Disclosures		64

	Item 6.	Exhibits		64

Signature				65

FORWARD-LOOKING STATEMENTS

From time to time, we make forward-looking statements such as statements regarding projected or future:

•

financial performance,

•

cash flows,

•

capital expenditures,

•

dividends,

•

capital structure,

•

other financial items,

•

strategic goals and objectives, and

•

plans for operations.

These statements have underlying assumptions (many of which are based, in turn, upon further assumptions). Such statements are made both in our reports filed under the Securities Exchange Act of 1934, as amended (including this Quarterly Report on Form 10-Q), and elsewhere. Forward-looking statements are all statements except those of historical fact including, without limitation, those that are identified by the use of words that include “will,” “may,” “could,” “should,” “intends,” “plans,” “seeks,” “anticipates,” “estimates,” “expects,” “forecasts,” “projects,” “predicts,” and similar expressions. Forward-looking statements (including those made in this Quarterly Report on Form 10-Q) are subject to a variety of risks and uncertainties and other factors. Many of these factors are beyond our control and they could have a significant effect on our operations, results of operations, financial condition or cash flows. This could cause actual results to differ materially from those anticipated in our statements. Such risks, uncertainties and other factors include, among others:

•

weather conditions (temperatures, precipitation levels and wind patterns) and their effects on energy demand and electric generation, including the effect of precipitation and temperatures on the availability of hydroelectric resources, the effect of wind patterns on the availability of wind resources, the effect of temperatures on customer demand, and similar impacts on supply and demand in the wholesale energy markets;

•

the effect of state and federal regulatory decisions on our ability to recover costs and earn a reasonable return including, but not limited to, the disallowance of costs and investments, and delay in the recovery of capital investments and operating costs;

•

changes in wholesale energy prices that can affect, among other things, the cash requirements to purchase electricity and natural gas, the value received for sales in the wholesale energy market, the necessity to request changes in rates that are subject to regulatory approval, collateral required of us by counterparties on wholesale energy transactions and credit risk to us from such transactions, and the market value of derivative assets and liabilities;

•

economic conditions in our service areas, including the effect on the demand for, and customers’ payment for, our utility services;

•

global financial and economic conditions (including the impact on capital markets) and their effect on our ability to obtain funding at a reasonable cost;

•

our 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;

•

the potential effects of legislation or administrative rulemaking, including the possible adoption of national or state laws requiring our resources to meet certain standards and placing restrictions on greenhouse gas emissions to mitigate concerns over global climate changes;

•

changes in actuarial assumptions, interest rates and the actual return on plan assets for our pension plan, which can affect future funding obligations, pension expense and pension plan liabilities;

•

volatility and illiquidity in wholesale energy markets, including the availability of willing buyers and sellers, and prices of purchased energy and demand for energy sales;

•

unplanned outages at any of our generating facilities or the inability of facilities to operate as intended;

•

the outcome of pending regulatory and legal proceedings arising out of the “western energy crisis” of 2000 and 2001, including possible refunds;

•

the outcome of legal proceedings and other contingencies;

•

changes in, and compliance with, environmental and endangered species laws, regulations, decisions and policies, including present and potential environmental remediation costs;

•

wholesale and retail competition including, but not limited to, alternative energy sources, suppliers and delivery arrangements;

•

the ability to comply with the terms of the licenses for our hydroelectric generating facilities at cost-effective levels;

•

natural disasters that can disrupt energy generation, transmission and distribution, as well as the availability and costs of materials, equipment, supplies and support services;

•

explosions, fires, accidents, or mechanical breakdowns that may occur while operating and maintaining our generation, transmission and distribution systems;

•

public injuries or damages arising from or allegedly arising from our operations

•

blackouts or disruptions of interconnected transmission systems;

•

disruption to information systems, automated controls and other technologies that we rely on for operations, communications and customer service;

•

the potential for terrorist attacks, cyber security attacks or other malicious acts, that cause damage to our utility assets, as well as the national economy in general; including the impact of acts of terrorism, cyber security attacks or vandalism that damage or disrupt information technology systems;

•

delays or changes in construction costs, and/or our ability to obtain required permits and materials for present or prospective facilities;

•

changes in the costs to implement new information technology systems, and/or other reasons that impair our ability to complete these projects in a timely and effective manner;

•

changes in the long-term climate of the Pacific Northwest, which can affect, among other things, customer demand patterns and the volume and timing of streamflows to our hydroelectric resources;

•

changes in industrial, commercial and residential growth and demographic patterns in our service territory or the loss of significant customers;

•

the loss of key suppliers for materials or services;

•

default or nonperformance on the part of any parties from which we purchase and/or sell capacity or energy;

•

deterioration in the creditworthiness of our customers and counterparties;

•

the effect of any potential decline in our credit ratings, including impeded access to capital markets, higher interest costs, and certain covenants with ratings triggers in our financing arrangements and wholesale energy contracts;

•

increasing health care costs and the resulting effect on health insurance provided to our employees and retirees;

•

increasing costs of insurance, more restricted coverage terms and our ability to obtain insurance;

•

work force issues, including changes in collective bargaining unit agreements, strikes, work stoppages, the loss of key executives, availability of workers in a variety of skill areas, and our ability to recruit and retain employees;

•

the potential effects of negative publicity regarding business practices, whether true or not, which could result in, among other things, costly litigation and a decline in our common stock price;

•

changes in technologies, possibly making some of the current technology obsolete;

•

changes in tax rates and/or policies;

•

changes in the payment acceptance policies of Ecova’s client vendors that could reduce operating revenues;

•

potential difficulties for Ecova in integrating acquired operations and in realizing expected opportunities, diversions of management resources and losses of key employees, challenges with respect to operating new businesses and other unanticipated risks and liabilities; and

•

changes in our strategic business plans, which may be affected by any or all of the foregoing, including the entry into new businesses and/or the exit from existing businesses.

Our expectations, beliefs and projections are expressed in good faith. We believe they are reasonable based on, without limitation, an examination of historical operating trends, our records and other information available from third parties. However, there can be no assurance that our expectations, beliefs or projections will be achieved or accomplished. Furthermore, any forward-looking statement speaks only as of the date on which such statement is made. We undertake no obligation to update any forward-looking statement or statements to reflect events or circumstances that occur after the date on which such statement is made or to reflect the occurrence of unanticipated events. New risks, uncertainties and other factors emerge from time to time, and it is not possible for us to predict all such factors, nor can we assess the effect of each such factor on our business or the extent that any such factor or combination of factors may cause actual results to differ materially from those contained in any forward-looking statement.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

Avista Corporation

For the Three Months Ended September 30

Dollars in thousands, except per share amounts

(Unaudited)


	2012			2011
Operating Revenues:
Utility revenues	$	292,085		$	301,551
Non-utility revenues		48,547			42,159

Total operating revenues		340,632			343,710


Operating Expenses:
Utility operating expenses:
Resource costs		153,801			171,393
Other operating expenses		64,449			60,579
Depreciation and amortization		28,255			26,341
Taxes other than income taxes		18,090			16,829
Non-utility operating expenses:
Other operating expenses		42,647			31,726
Depreciation and amortization		3,391			1,964

Total operating expenses		310,633			308,832


Income from operations		29,999			34,878

Interest expense		19,128			18,703
Interest expense to affiliated trusts		136			152
Capitalized interest		(644	)		(957	)
Other expense-net		3,809			1,626

Income before income taxes		7,570			15,354
Income tax expense		1,608			3,717

Net income		5,962			11,637

Net income attributable to noncontrolling interests		(176	)		(935	)

Net income attributable to Avista Corporation	$	5,786		$	10,702

Weighted-average common shares outstanding (thousands), basic		59,047			58,057

Weighted-average common shares outstanding (thousands), diluted		59,123			58,232

Earnings per common share attributable to Avista Corporation:
Basic	$	0.10		$	0.18

Diluted	$	0.10		$	0.18

Dividends paid per common share	$	0.29		$	0.275

The Accompanying Notes are an Integral Part of These Statements.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

Avista Corporation

For the Nine Months Ended September 30

Dollars in thousands, except per share amounts

(Unaudited)


	2012			2011
Operating Revenues:
Utility revenues	$	990,860		$	1,059,221
Non-utility revenues		145,614			121,632

Total operating revenues		1,136,474			1,180,853


Operating Expenses:
Utility operating expenses:
Resource costs		500,805			575,290
Other operating expenses		191,407			188,961
Depreciation and amortization		83,327			78,600
Taxes other than income taxes		63,622			61,521
Non-utility operating expenses:
Other operating expenses		130,327			95,581
Depreciation and amortization		9,966			5,673

Total operating expenses		979,454			1,005,626


Income from operations		157,020			175,227

Interest expense		57,453			55,415
Interest expense to affiliated trusts		413			455
Capitalized interest		(1,765	)		(2,209	)
Other expense-net		5,106			3,061

Income before income taxes		95,813			118,505
Income tax expense		33,106			40,937

Net income		62,707			77,568

Net income attributable to noncontrolling interests		(355	)		(1,947	)

Net income attributable to Avista Corporation	$	62,352		$	75,621

Weighted-average common shares outstanding (thousands), basic		58,778			57,731

Weighted-average common shares outstanding (thousands), diluted		59,026			57,934

Earnings per common share attributable to Avista Corporation:
Basic	$	1.06		$	1.31

Diluted	$	1.06		$	1.30

Dividends paid per common share	$	0.87		$	0.825

The Accompanying Notes are an Integral Part of These Statements.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

Avista Corporation

For the Three Months Ended September 30

Dollars in thousands

(Unaudited)


	2012			2011

Net income	$	5,962		$	11,637

Other Comprehensive Income:

Unrealized investment gains - net of taxes of $68		110			—

Reclassification adjustment for realized gains on investment securities included in net income - net of taxes of $(11)		(17	)		—

Change in unfunded benefit obligation for pension and other postretirement benefit plans - net of taxes of $90 and $66, respectively		168			123

Total other comprehensive income		261			123

Comprehensive income		6,223			11,760

Comprehensive income attributable to noncontrolling interests		(176	)		(935	)

Comprehensive income attributable to Avista Corporation	$	6,047		$	10,825

For the Nine Months Ended September 30

Dollars in thousands

(Unaudited)


	2012			2011

Net income	$	62,707		$	77,568


Other Comprehensive Income (Loss):

Unrealized investment gains - net of taxes of $244		409			—

Reclassification adjustment for realized gains on investment securities included in net income - net of taxes of $(94)		(158	)		—

Change in unfunded benefit obligation for pension and other postretirement benefit plans - net of taxes of $263 and $(7), respectively		489			(13	)


Total other comprehensive income (loss)		740			(13	)


Comprehensive income		63,447			77,555

Comprehensive income attributable to noncontrolling interests		(355	)		(1,947	)


Comprehensive income attributable to Avista Corporation	$	63,092		$	75,608

The Accompanying Notes are an Integral Part of These Statements.

CONDENSED CONSOLIDATED BALANCE SHEETS

Avista Corporation

Dollars in thousands

(Unaudited)


	September 30, 2012		December 31, 2011
Assets:
Current Assets:
Cash and cash equivalents	$	82,952	$	74,662
Accounts and notes receivable-less allowances of $44,354 and $43,958		141,659		203,452
Utility energy commodity derivative assets		1,678		1,139
Regulatory asset for utility derivatives		41,251		69,685
Investments and funds held for clients		114,226		118,536
Materials and supplies, fuel stock and natural gas stored		51,066		52,006
Deferred income taxes		35,792		30,473
Income taxes receivable		15,907		15,378
Other current assets		31,785		49,225

Total current assets		516,316		614,556


Net Utility Property:
Utility plant in service		3,994,743		3,887,384
Construction work in progress		116,624		79,322

Total		4,111,367		3,966,706
Less: Accumulated depreciation and amortization		1,170,845		1,105,930

Total net utility property		2,940,522		2,860,776


Other Non-current Assets:
Investment in exchange power-net		16,946		18,783
Investment in affiliated trusts		11,547		11,547
Goodwill		73,783		39,045
Long-term energy contract receivable of Spokane Energy		54,740		62,525
Other intangibles, property and investments-net		92,956		80,309

Total other non-current assets		249,972		212,209


Deferred Charges:
Regulatory assets for deferred income tax		76,616		84,576
Regulatory assets for pensions and other postretirement benefits		248,082		260,359
Other regulatory assets		102,998		119,738
Non-current utility energy commodity derivative assets		1,073		185
Non-current regulatory asset for utility derivatives		30,111		40,345
Other deferred charges		24,566		21,787

Total deferred charges		483,446		526,990


Total assets	$	4,190,256	$	4,214,531

The Accompanying Notes are an Integral Part of These Statements.

CONDENSED CONSOLIDATED BALANCE SHEETS (continued)

Avista Corporation

Dollars in thousands

(Unaudited)


	September 30, 2012			December 31, 2011
Liabilities and Equity:
Current Liabilities:
Accounts payable	$	140,536		$	166,954
Client fund obligations		113,614			118,325
Current portion of long-term debt		392			7,474
Current portion of nonrecourse long-term debt of Spokane Energy		14,631			13,668
Short-term borrowings		82,000			96,000
Utility energy commodity derivative liabilities		35,788			70,824
Natural gas deferrals		13,169			12,140
Other current liabilities		147,723			141,789

Total current liabilities		547,853			627,174

Long-term debt		1,148,047			1,169,826
Nonrecourse long-term debt of Spokane Energy		21,688			32,803
Long-term debt to affiliated trusts		51,547			51,547
Long-term borrowings under committed line of credit		58,000			—
Regulatory liability for utility plant retirement costs		231,497			227,282
Pensions and other postretirement benefits		214,838			246,177
Deferred income taxes		527,397			505,954
Other non-current liabilities and deferred credits		105,481			116,084


Total liabilities		2,906,348			2,976,847


Commitments and Contingencies (See Notes to Condensed Consolidated Financial Statements)


Redeemable Noncontrolling Interests		6,726			51,809


Equity:
Avista Corporation Stockholders’ Equity:
Common stock, no par value; 200,000,000 shares authorized; 59,754,870 and 58,422,781 shares outstanding		887,530			855,188
Accumulated other comprehensive loss		(4,897	)		(5,637	)
Retained earnings		377,111			336,150

Total Avista Corporation stockholders’ equity		1,259,744			1,185,701
Noncontrolling Interests		17,438			174

Total equity		1,277,182			1,185,875


Total liabilities and equity	$	4,190,256		$	4,214,531

The Accompanying Notes are an Integral Part of These Statements.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

Avista Corporation

For the Nine Months Ended September 30

Dollars in thousands

(Unaudited)


	2012			2011
Operating Activities:
Net income	$	62,707		$	77,568
Non-cash items included in net income:
Depreciation and amortization		93,293			84,273
Provision for deferred income taxes		18,380			30,783
Power and natural gas cost amortizations, net		10,418			9,470
Amortization of debt expense and premium		2,876			3,186
Equity-related AFUDC		(2,875	)		(1,655	)
Other		52,859			32,958
Contributions to defined benefit pension plan		(44,000	)		(26,000	)
Changes in working capital components:
Accounts and notes receivable		61,106			76,285
Materials and supplies, fuel stock and natural gas stored		941			(16,260	)
Other current assets		7,209			(28,167	)
Accounts payable		(10,783	)		(11,994	)
Other current liabilities		5,277			9,977

Net cash provided by operating activities		257,408			240,424


Investing Activities:
Utility property capital expenditures (excluding equity-related AFUDC)		(178,440	)		(169,598	)
Other capital expenditures		(3,908	)		(2,730	)
Federal grant payments received		5,902			13,398
Cash paid by subsidiaries for acquisitions, net of cash received		(50,310	)		(199	)
Decrease (increase) in funds held for clients		(9,599	)		43,321
Purchase of securities available for sale		(88,843	)		(47,299	)
Sale and maturity of securities available for sale		103,545			—
Other		(7,412	)		(4,604	)

Net cash used in investing activities		(229,065	)		(167,711	)


Financing Activities:
Net increase (decrease) in short-term borrowings		21,000			(13,500	)
Borrowings from Ecova line of credit		28,000			—
Repayment of borrowings from Ecova line of credit		(5,000	)		—
Redemption and maturity of long-term debt		(11,363	)		(204	)
Maturity of nonrecourse long-term debt of Spokane Energy		(10,153	)		(9,258	)
Long-term debt and short-term borrowing issuance costs		(177	)		(2,362	)
Cash paid for settlement of interest rate swap agreements		(18,547	)		(10,557	)
Issuance of common stock		28,699			21,216
Cash dividends paid		(51,215	)		(47,685	)
Purchase of subsidiary noncontrolling interest		(917	)		(6,179	)
Increase (decrease) in client fund obligations		(5,220	)		3,978
Issuance of subsidiary noncontrolling interests		3,714			—
Other		1,126			528

Net cash used in financing activities		(20,053	)		(64,023	)


Net increase in cash and cash equivalents		8,290			8,690

Cash and cash equivalents at beginning of period		74,662			69,413


Cash and cash equivalents at end of period	$	82,952		$	78,103


Supplemental Cash Flow Information:
Cash paid during the period:
Interest	$	43,487		$	41,582
Income taxes		12,527			24,506
Non-cash financing and investing activities:
Accounts payable for capital expenditures		3,556			2,642
Redeemable noncontrolling interests		(8,274	)		5,147

The Accompanying Notes are an Integral Part of These Statements.

CONDENSED CONSOLIDATED STATEMENTS OF EQUITY

AND REDEEMABLE NONCONTROLLING INTERESTS

Avista Corporation

For the Nine Months Ended September 30

Dollars in thousands

(Unaudited)


	2012			2011
Common Stock, Shares:
Shares outstanding at beginning of period		58,422,781			57,119,723
Issuance of common stock		1,332,089			1,081,274

Shares outstanding at end of period		59,754,870			58,200,997


Common Stock, Amount:
Balance at beginning of period	$	855,188		$	827,592
Equity compensation expense		3,354			2,718
Issuance of common stock, net of issuance costs		28,699			21,216
Equity transactions of consolidated subsidiaries		289			(2,817	)

Balance at end of period		887,530			848,709


Accumulated Other Comprehensive Loss:
Balance at beginning of period		(5,637	)		(4,326	)
Other comprehensive income (loss)		740			(13	)

Balance at end of period		(4,897	)		(4,339	)


Retained Earnings:
Balance at beginning of period		336,150			302,518
Net income attributable to Avista Corporation		62,352			75,621
Cash dividends paid (common stock)		(51,215	)		(47,685	)
Expiration of subsidiary noncontrolling interests redemption rights		23,805			—
Valuation adjustments and other noncontrolling interests activity		6,019			(3,906	)

Balance at end of period		377,111			326,548


Total Avista Corporation stockholders’ equity		1,259,744			1,170,918


Noncontrolling Interests:
Balance at beginning of period		174			(600	)
Net income attributable to noncontrolling interests		234			95
Deconsolidation of variable interest entity		(673	)		—
Purchase of subsidiary noncontrolling interests		(117	)		—
Expiration of subsidiary noncontrolling interests redemption rights		17,790			—
Other		30			(25	)

Balance at end of period		17,438			(530	)


Total equity	$	1,277,182		$	1,170,388


Redeemable Noncontrolling Interests:
Balance at beginning of period	$	51,809		$	46,722
Net income attributable to noncontrolling interests		121			1,852
Issuance of subsidiary noncontrolling interests		3,714			—
Purchase of subsidiary noncontrolling interests		(784	)		(6,179	)
Expiration of subsidiary noncontrolling interests redemption rights		(41,595	)		—
Valuation adjustments and other noncontrolling interests activity		(6,539	)		9,675

Balance at end of period	$	6,726		$	52,070

The Accompanying Notes are an Integral Part of These Statements.

AVISTA CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

The accompanying condensed consolidated financial statements of Avista Corporation (Avista Corp. or the Company) for the interim periods ended September 30, 2012 and 2011 are unaudited; however, in the opinion of management, the statements reflect all adjustments necessary for a fair statement of the results for the interim periods. The condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. The Condensed Consolidated Statements of Income for the interim periods are not necessarily indicative of the results to be expected for the full year. These condensed consolidated financial statements do not contain the detail or footnote disclosure concerning accounting policies and other matters which would be included in full fiscal year consolidated financial statements; therefore, they should be read in conjunction with the Company’s audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011 (2011 Form 10-K). Please refer to the section “Acronyms and Terms” in the 2011 Form 10-K for definitions of terms. The acronyms and terms are an integral part of these condensed consolidated financial statements.

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Business

Avista Corp. is an energy company engaged in the generation, transmission and distribution of energy, as well as other energy-related businesses. Avista Utilities is an operating division of Avista Corp., comprising the regulated utility operations. Avista Utilities generates, transmits and distributes electricity in parts of eastern Washington and northern Idaho. In addition, Avista Utilities has electric generating facilities in Montana and northern Oregon. Avista Utilities also provides natural gas distribution service in parts of eastern Washington and northern Idaho, as well as parts of northeast and southwest Oregon. Avista Capital, Inc. (Avista Capital), a wholly owned subsidiary of Avista Corp., is the parent company of all of the subsidiary companies in the non-utility businesses, except Spokane Energy, LLC (Spokane Energy). Avista Capital’s subsidiaries include Ecova, Inc. (Ecova), a 79.0 percent owned subsidiary as of September 30, 2012. Ecova is a provider of energy efficiency and other facility information and cost management programs and services for multi-site customers and utilities throughout North America. See Note 12 for business segment information.

Basis of Reporting

The condensed consolidated financial statements include the assets, liabilities, revenues and expenses of the Company and its subsidiaries, including Ecova and other majority owned subsidiaries and variable interest entities for which the Company or its subsidiaries are the primary beneficiaries. Intercompany balances were eliminated in consolidation. The accompanying condensed consolidated financial statements include the Company’s proportionate share of utility plant and related operations resulting from its interests in jointly owned plants.

Taxes Other Than Income Taxes

Taxes other than income taxes include state excise taxes, city occupational and franchise taxes, real and personal property taxes and certain other taxes not based on net income. These taxes are generally based on revenues or the value of property. Utility related taxes collected from customers (primarily state excise taxes and city utility taxes) are recorded as operating revenue and expense and totaled the following amounts 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
Utility taxes	$	10,741	$	10,270	$	41,353	$	41,551

Other Expense - Net

Other expense - net consisted of the following items 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
Interest income	$	(166	)	$	(455	)	$	(804	)	$	(1,029	)
Interest on regulatory deferrals		(19	)		(15	)		(43	)		(83	)
Equity-related AFUDC		(1,127	)		(421	)		(2,875	)		(1,655	)
Net loss on investments		2,430			560			2,957			597
Other expense		2,877			1,957			7,040			5,466
Other income		(186	)		—			(1,169	)		(235	)

Total	$	3,809		$	1,626		$	5,106		$	3,061

AVISTA CORPORATION

Included in net loss on investments for the three months and nine months ended September 30, 2012 are impairment losses of $2.4 million related to the impairment of the Company’s investment in a fuel cell business and the write-off of the Company’s investment in a solar energy company.

Investments and Funds Held for Clients and Client Fund Obligations

In connection with the bill paying services, Ecova collects funds from its clients and remits the funds to the appropriate utility or other service provider. Some of the funds collected are invested by Ecova and classified as investments and funds held for clients and a related liability for client fund obligations is recorded. Investments and funds held for clients include cash and cash equivalent investments and investment securities classified as available for sale. Investments and funds held for clients as of September 30, 2012 are as follows (dollars in thousands):


	Amortized Cost		Unrealized Gain		Fair Value
Cash and cash equivalents	$	31,874	$	—	$	31,874
Securities available for sale:
U.S. government agency		63,207		251		63,458
Municipal		5,049		133		5,182
Corporate fixed income – financial		6,544		90		6,634
Corporate fixed income – industrial		4,905		94		4,999
Corporate fixed income – utility		1,035		33		1,068
Certificates of deposit		1,000		11		1,011

Total securities available for sale		81,740		612		82,352

Total investments and funds held for clients	$	113,614	$	612	$	114,226

Investments and funds held for clients as of December 31, 2011 were as follows (dollars in thousands):


	Amortized Cost		Unrealized Gain (Loss)			Fair Value
Cash and cash equivalents	$	21,957	$	—		$	21,957
Securities available for sale:
U.S. government agency		74,721		172			74,893
Municipal		425		—			425
Corporate fixed income – financial		11,139		15			11,154
Corporate fixed income – industrial		6,495		23			6,518
Corporate fixed income – utility		2,088		4			2,092
Certificates of deposit		1,500		(3	)		1,497

Total securities available for sale		96,368		211			96,579

Total investments and funds held for clients	$	118,325	$	211		$	118,536

Investments and funds held for clients are classified as a current asset since these funds are held for the purpose of satisfying the client fund obligations. Approximately 93 percent and 88 percent of the investment portfolio was rated AA or higher as of September 30, 2012 and December 31, 2011, respectively, by nationally recognized statistical rating organizations. All fixed income securities were rated at least investment grade as of September 30, 2012 and December 31, 2011.

Proceeds from sales, maturities and calls of securities available for sale were $103.5 million for the nine months ended September 30, 2012 with gross realized gains of $0.3 million and there were not any gross realized losses. Proceeds from sales, maturities and calls of securities available for sale were $32.0 million for the three months ended September 30, 2012 with gross realized gains of $0.1 million and there were not any gross realized losses. There were no sales, maturities and calls of securities available for sale during the first nine months of 2011.

Contractual maturities of securities available for sale (at fair value) as of September 30, 2012 and December 31, 2011 are as follows (dollars in thousands):


	Due within 1 year		After 1 but within 5 years		After 5 but within 10 years		After 10 years		Total
September 30, 2012	$	2,455	$	17,109	$	55,789	$	6,999	$	82,352
December 31, 2011		425		55,126		41,028		—		96,579

Actual maturities may differ due to call or prepayment rights and the effective duration was 1.8 years as of September 30, 2012 and 1.3 years as of December 31, 2011.

AVISTA CORPORATION

Goodwill

Goodwill arising from acquisitions represents the excess of the purchase price over the estimated fair value of net assets acquired. The Company evaluates goodwill for impairment using a discounted cash flow model on at least an annual basis or more frequently if impairment indicators arise. The Company completed its annual evaluation of goodwill for potential impairment as of November 30, 2011 for the other businesses and as of December 31, 2011 for Ecova and determined that goodwill was not impaired at that time. The changes in the carrying amount of goodwill are as follows (dollars in thousands):


	Ecova		Other		Accumulated Impairment Losses			Total
Balance as of December 31, 2011	$	33,799	$	12,979	$	(7,733	)	$	39,045
Goodwill acquired during the period		33,484		—		—			33,484
Adjustments		1,254		—		—			1,254

Balance as of the September 30, 2012	$	68,537	$	12,979	$	(7,733	)	$	73,783

Accumulated impairment losses are attributable to the other businesses. The goodwill acquired in 2012 was related to Ecova’s acquisition of LPB Energy Management (LPB) effective January 31, 2012. The adjustment to goodwill recorded represents purchase accounting adjustments for Ecova’s acquisition of Prenova based upon further review of the fair market values of relevant assets and liabilities identified as of the acquisition date.

Other Intangibles

Other Intangibles represent the amounts assigned to client relationships related to the Ecova acquisition of Cadence Network in 2008 (estimated amortization period of 12 years), Ecos in 2009 (estimated amortization period of 3 years), Loyalton in 2010 (estimated amortization period of 6 years), Prenova in 2011 (estimated amortization period of 9 years) and LPB in 2012 (estimated amortization period of 3 to 10 years), software development costs (estimated amortization period of 3 to 7 years) and other. Other Intangibles are included in other intangibles, property and investments - net on the Condensed Consolidated Balance Sheets. Amortization expense related to Other Intangibles was as follows 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
Other intangible amortization	$	2,436	$	1,145	$	7,091	$	3,298

The following table details the future estimated amortization expense related to Other Intangibles for each of the five years ending December 31 (dollars in thousands):


	2012		2013		2014		2015		2016
Estimated amortization expense	$	2,268	$	8,899	$	7,929	$	5,633	$	4,687

The gross carrying amount and accumulated amortization of Other Intangibles as of September 30, 2012 and December 31, 2011 are as follows (dollars in thousands):


	September 30,			December 31,
	2012			2011
Client relationships	$	32,959		$	18,859
Software development costs		32,935			29,327
Other		5,672			3,065

Total other intangibles		71,566			51,251

Client relationships accumulated amortization		(6,871	)		(3,623	)
Software development costs accumulated amortization		(15,392	)		(12,016	)
Other accumulated amortization		(1,480	)		(990	)

Total accumulated amortization		(23,743	)		(16,629	)

Total other intangibles - net	$	47,823		$	34,622

Derivative Assets and Liabilities

Derivatives are recorded as either assets or liabilities on the Condensed Consolidated Balance Sheets measured at estimated fair value. In certain defined conditions, a derivative may be specifically designated as a hedge for a particular exposure. The accounting for derivatives depends on the intended use of the derivatives and the resulting designation.

The Washington Utilities and Transportation Commission (WUTC) and the Idaho Public Utilities Commission (IPUC) issued accounting orders authorizing Avista Utilities to offset commodity derivative assets or liabilities with a regulatory asset or liability. This accounting treatment is intended to defer the recognition of mark-to-market gains and losses on energy commodity transactions until the period of settlement. The orders provide for Avista Utilities to not recognize the unrealized gain or loss on utility derivative commodity instruments in the Condensed Consolidated Statements of Income. Realized gains or losses are recognized in the period of settlement, subject to approval for recovery through retail rates. Realized gains and losses, subject to regulatory approval, result in adjustments to retail rates through purchased gas cost adjustments, the Energy Recovery Mechanism (ERM) in Washington, the Power Cost Adjustment (PCA) mechanism in Idaho, and periodic general rates cases. Regulatory assets are assessed regularly and are probable for recovery through future rates.

AVISTA CORPORATION

Substantially all forward contracts to purchase or sell power and natural gas are recorded as derivative assets or liabilities at estimated fair value with an offsetting regulatory asset or liability. Contracts that are not considered derivatives are accounted for on the accrual basis until they are settled or realized, unless there is a decline in the fair value of the contract that is determined to be other than temporary.

Fair Value Measurements

Fair value represents the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date. Energy commodity derivative assets and liabilities, investments and funds held for clients, deferred compensation assets, as well as derivatives related to interest rate swap agreements and foreign currency exchange contracts, are reported at estimated fair value on the Condensed Consolidated Balance Sheets. See Note 9 for the Company’s fair value disclosures.

Regulatory Deferred Charges and Credits

The Company prepares its condensed consolidated financial statements in accordance with regulatory accounting practices because:

•

rates for regulated services are established by or subject to approval by independent third-party regulators,

•

the regulated rates are designed to recover the cost of providing the regulated services, and

•

in view of demand for the regulated services and the level of competition, it is reasonable to assume that rates can be charged to and collected from customers at levels that will recover costs.

Regulatory accounting practices require that certain costs and/or obligations (such as incurred power and natural gas costs not currently included in rates, but expected to be recovered or refunded in the future) are reflected as deferred charges or credits on the Condensed Consolidated Balance Sheets. These costs and/or obligations are not reflected in the Condensed Consolidated Statements of Income until the period during which matching revenues are recognized. If at some point in the future the Company determines that it no longer meets the criteria for continued application of regulatory accounting practices for all or a portion of its regulated operations, the Company could be:

•

required to write off its regulatory assets, and

•

precluded from the future deferral of costs not recovered through rates at the time such costs are incurred, even if the Company expected to recover such costs in the future.

Contingencies

The Company has unresolved regulatory, legal and tax issues which have inherently uncertain outcomes. The Company accrues a loss contingency if it is probable that a liability has been incurred and the amount of the loss or impairment can be reasonably estimated. The Company also discloses losses that do not meet these conditions for accrual, if there is a reasonable possibility that a loss may be incurred.

NOTE 2. NEW ACCOUNTING STANDARDS

Effective January 1, 2012, the Company adopted Accounting Standards Update (ASU) No. 2011-04, “Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.” This ASU requires enhanced disclosures for fair value measurements, including quantitative analysis of unobservable inputs used in Level 3 fair value measurements. The ASU also clarifies the FASB’s intent about the application of existing fair value measurement requirements. The adoption of this ASU did not have any impact on the Company’s financial condition, results of operations and cash flows. See Note 9 for the Company’s fair value disclosures.

In September 2011, the Financial Accounting Standards Board (FASB) issued ASU No. 2011-08, “Intangibles – Goodwill and Other (Topic 350): Testing Goodwill for Impairment.” This ASU amends the guidance on testing goodwill for impairment, providing entities with the option of performing a qualitative assessment before calculating the fair value of the reporting unit. If it is determined, on the basis of the qualitative assessment, that the fair value of the reporting unit is more likely than not less than the carrying amount, the two-step impairment test would be required. This ASU does not change how goodwill is calculated or assigned to reporting units, nor does it revise the requirement to test goodwill annually for impairment. This ASU is effective for goodwill impairment tests performed for fiscal years beginning after December 15, 2011, with early adoption permitted. The Company does not expect that this ASU will have any material impact on its testing of goodwill for impairment.

AVISTA CORPORATION

NOTE 3. VARIABLE INTEREST ENTITIES

The Company has a power purchase agreement (PPA) for the purchase of all the output of the Lancaster Plant, a 270 MW natural gas-fired combined cycle combustion turbine plant located in Idaho, owned by an unrelated third-party (Rathdrum Power LLC), through 2026.

Avista Corp. has a variable interest in the PPA. Accordingly, Avista Corp. made an evaluation of which interest holders have the power to direct the activities that most significantly impact the economic performance of the entity and which interest holders have the obligation to absorb losses or receive benefits that could be significant to the entity. Avista Corp. pays a fixed capacity and operations and maintenance payment and certain monthly variable costs under the PPA. Under the terms of the PPA, Avista Corp. makes the dispatch decisions, provides all natural gas fuel and receives all of the electric energy output from the Lancaster Plant. However, Rathdrum Power LLC (the owner) controls the daily operation of the Lancaster Plant and makes operating and maintenance decisions. Rathdrum Power LLC controls all of the rights and obligations of the Lancaster Plant after the expiration of the PPA in 2026. It is estimated that the plant will have 15 to 25 years of useful life after that time. Rathdrum Power LLC bears the maintenance risk of the plant and will receive the residual value of the Lancaster Plant. Avista Corp. has no debt or equity investments in the Lancaster Plant and does not provide financial support through liquidity arrangements or other commitments (other than the PPA). Based on its analysis, Avista Corp. does not consider itself to be the primary beneficiary of the Lancaster Plant. Accordingly, neither the Lancaster Plant nor Rathdrum Power LLC is included in Avista Corp.’s condensed consolidated financial statements. The Company has a future contractual obligation of approximately $325 million under the PPA (representing the fixed capacity and operations and maintenance payments through 2026) and believes this would be its maximum exposure to loss. However, the Company believes that such costs will be recovered through retail rates.

Ecova formed a partnership, SEEL, LLC (SEEL) with a third party for the purpose of entering into utility contracts to provide energy efficiency services. SEEL is funded 49 percent by Ecova and 51 percent by the third party. Prior to 2012, Ecova determined that it was the primary beneficiary of SEEL based on its management of the entity and its technical expertise in obtaining and fulfilling the utility contracts, and Ecova was obligated to absorb the losses or receive the benefits that could be significant to SEEL. In 2012, Ecova is no longer the primary beneficiary of SEEL because it is no longer the sole provider of the technical expertise necessary to obtain and fulfill utility contracts. As of January 1, 2012, Ecova uses the equity method to account for its arrangement with SEEL.

NOTE 4. REDEEMABLE NONCONTROLLING INTERESTS AND SUBSIDIARY ACQUISITIONS

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 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. As such, this redeemable noncontrolling interest was reclassified to equity effective July 31, 2012. Additionally, certain minority shareholders and option holders of Ecova have the right to put their shares back to Ecova at their discretion during an annual put window. Stock options and other outstanding redeemable stock are valued at their maximum redemption amount which is equal to their intrinsic value (fair value less exercise price). The following details redeemable noncontrolling interests as of September 30, 2012 and December 31, 2011 (dollars in thousands):


	September 30,		December 31,
	2012		2011
Previous owners of Cadence Network	$	—	$	38,893
Stock options and other outstanding redeemable stock		6,726		12,916

Total redeemable noncontrolling interests	$	6,726	$	51,809

On November 30, 2011, Ecova acquired Prenova, Inc. (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. The acquired assets and assumed liabilities of Prenova were recorded at their respective estimated fair values as of the date of acquisition. Final purchase accounting is pending the completion of further review of the fair market values of relevant assets and liabilities identified as of the acquisition date. The results of operations of Prenova are included in the condensed consolidated financial statements beginning December 1, 2011.

AVISTA CORPORATION

On January 31, 2012, Ecova acquired LPB Energy Management (LPB), a Dallas, Texas-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 certain other owners of Ecova), and available cash. The acquired assets and assumed liabilities of LPB were recorded at their respective estimated fair values as of the date of acquisition. Assets recorded include the following: accounts receivable of $2.5 million, goodwill of $33.5 million, client backlog of $8.2 million (estimated amortization period of 3 years), client relationships of $4.8 million (estimated amortization period of 10 years) and internal use software of $2.5 million (estimated amortization period of 3 to 4 years). These intangible assets are included in other intangibles, property and investments on the Condensed Consolidated Balance Sheet. Final purchase accounting is pending the completion of further review of the fair market values of relevant assets and liabilities identified as of the acquisition date. The results of operations of LPB are included in the condensed consolidated financial statements beginning February 1, 2012. The sellers of LPB have the potential to receive additional purchase price payments of $0.5 million in 2012, $1.0 million in 2013 and $1.5 million in 2014. These payments are contingent upon reaching certain revenue thresholds for certain customer contracts. As of September 30, 2012, Ecova has recorded a contingent liability of $0.4 million based on management’s assessment of the probability of the revenue thresholds being achieved.

Pro forma disclosures reflecting the effects of Ecova’s acquisitions are not presented, as the acquisitions are not material to Avista Corp.’s condensed consolidated results of operations.

NOTE 5. DERIVATIVES AND RISK MANAGEMENT

Energy Commodity Derivatives

Avista Utilities is exposed to market risks relating to changes in electricity and natural gas commodity prices and certain other fuel prices. Market risk is, in general, the risk of fluctuation in the market price of the commodity being traded and is influenced primarily by supply and demand. Market risk includes the fluctuation in the market price of associated derivative commodity instruments. Avista Utilities utilizes derivative instruments, such as forwards, futures, swaps and options in order to manage the various risks relating to these commodity price exposures. The Company has an energy resources risk policy and control procedures to manage these risks. The Company’s Risk Management Committee establishes the Company’s energy resources risk policy and monitors compliance. The Risk Management Committee is comprised of certain Company officers and other members of management. The Audit Committee of the Company’s Board of Directors periodically reviews and discusses enterprise risk management processes, and it focuses on the Company’s material financial and accounting risk exposures and the steps management has undertaken to control them.

As part of its resource procurement and management operations in the electric business, Avista Utilities engages in an ongoing process of resource optimization, which involves the economic selection from available energy resources to serve Avista Utilities’ load obligations and the use of these resources to capture available economic value. Avista Utilities sells and purchases wholesale electric capacity and energy and fuel as part of the process of acquiring and balancing resources to serve its load obligations. These transactions range from terms of 30 minutes up to multiple years.

Avista Utilities makes continuing projections of:

•

electric loads at various points in time (ranging from 30 minutes to multiple years) based on, among other things, estimates of customer usage and weather, historical data and contract terms, and

•

resource availability at these points in time based on, among other things, fuel choices and fuel markets, estimates of streamflows, availability of generating units, historic and forward market information, contract terms, and experience.

On the basis of these projections, Avista Utilities makes purchases and sales of electric capacity and energy and fuel to match expected resources to expected electric load requirements. Resource optimization involves generating plant dispatch and scheduling available resources and also includes transactions such as:

•

purchasing fuel for generation,

•

when economical, selling fuel and substituting wholesale electric purchases, and

•

other wholesale transactions to capture the value of generation and transmission resources and fuel delivery capacity contracts.

Avista Utilities’ optimization process includes entering into hedging transactions to manage risks.

As part of its resource procurement and management of its natural gas business, Avista Utilities makes continuing projections of its natural gas loads and assesses available natural gas resources including natural gas storage availability. Natural gas resource planning typically includes peak requirements, low and average monthly requirements and delivery constraints from natural gas supply locations to Avista Utilities’ distribution system. However, daily variations in natural gas demand can be significantly different than monthly demand projections. On the basis of these projections, Avista Utilities plans and executes a series of transactions to hedge a significant portion of its projected natural gas requirements through forward market transactions and derivative instruments. These transactions may extend as much as four natural gas operating years (November through October) into the future. Avista Utilities also leaves a significant portion of its natural gas supply requirements unhedged for purchase in short-term and spot markets.

AVISTA CORPORATION

Natural gas resource optimization activities include:

•

wholesale market sales of surplus natural gas supplies,

•

optimization of interstate pipeline transportation capacity not needed to serve daily load, and

•

purchases and sales of natural gas to optimize use of storage capacity.

The following table presents the underlying energy commodity derivative volumes as of September 30, 2012 that are expected to settle in each respective year (in thousands of MWhs and mmBTUs):


	Purchases								Sales
	Electric Derivatives				Gas Derivatives				Electric Derivatives				Gas Derivatives
	Physical		Financial		Physical		Financial		Physical		Financial		Physical		Financial
Year	MWH		MWH		mmBTUs		mmBTUs		MWH		MWH		mmBTUs		mmBTUs
2012		766		711		8,726		30,181		126		488		2,642		29,878
2013		594		2,237		14,816		79,548		309		2,446		4,432		63,423
2014		397		620		6,316		51,359		409		1,697		1,786		29,587
2015		379		614		3,390		19,205		286		614		—		17,325
2016		366		—		1,365		455		287		—		—		—
Thereafter		949		—		—		—		730		—		—		—

Interest Rate Swap Agreements

Avista Corp. hedges a portion of its interest rate risk with financial derivative instruments, which may include interest rate swaps and U.S. Treasury lock agreements. These interest rate swap agreements are considered economic hedges against fluctuations in future cash flows associated with anticipated debt issuances. The following table summarizes the interest rate swaps that the Company has entered into as of September 30, 2012 and December 31, 2011 (dollars in thousands):


	September 30,		December 31,
	2012		2011
Number of contracts		—		3
Notional amount		—	$	75,000
Mandatory cash settlement date		—		July 2012
Number of contracts		2		2
Notional amount	$	85,000	$	85,000
Mandatory cash settlement date		June 2013		June 2013
Number of contracts		2		—
Notional amount	$	50,000		—
Mandatory cash settlement date		October 2014		—
Number of contracts		1		—
Notional amount	$	25,000		—
Mandatory cash settlement date		October 2015		—

In May 2012, the Company 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 (see Note 8). 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.

AVISTA CORPORATION

Foreign Currency Exchange Contracts

A significant portion of Avista Utilities’ natural gas supply (including fuel for power generation) is obtained from Canadian sources. Most of those transactions are executed in U.S. dollars, which avoids foreign currency risk. A portion of Avista Utilities’ short-term natural gas transactions and long-term Canadian transportation contracts are committed based on Canadian currency prices and settled within sixty days with U.S. dollars. Avista Utilities economically hedges a portion of the foreign currency risk by purchasing Canadian currency contracts when such commodity transactions are initiated. This risk has not had a material effect on the Company’s financial condition, results of operations or cash flows and these differences in cost related to currency fluctuations were included with natural gas supply costs for ratemaking. The following table summarizes the foreign currency hedges that the Company has entered into as of September 30, 2012 and December 31, 2011 (dollars in thousands):


	September 30,		December 31,
	2012		2011
Number of contracts		30		28
Notional amount (in United States dollars)	$	6,578	$	7,033
Notional amount (in Canadian dollars)	$	6,469	$	7,192

Derivative Instruments Summary

The following table presents the fair values and locations of derivative instruments recorded on the Condensed Consolidated Balance Sheet as of September 30, 2012 (in thousands):


		Fair Value
Derivative	Balance Sheet Location	Asset		Liability			Collateral Netting		Net Asset (Liability)
Foreign currency contracts	Other current liabilities	$	—	$	(30	)	$	—	$	(30	)
Interest rate contracts	Other current liabilities		—		(3,827	)		—		(3,827	)
Interest rate contracts	Other intangibles, property and investments - net		5,069		—			—		5,069
Commodity contracts	Current utility energy commodity derivative assets		1,857		(179	)		—		1,678
Commodity contracts	Non-current utility energy commodity derivative assets		1,709		(636	)		—		1,073
Commodity contracts	Current utility energy commodity derivative liabilities		46,879		(89,805	)		7,138		(35,788	)
Commodity contracts	Other non-current liabilities and deferred credits		26,616		(57,800	)		2,336		(28,848	)

Total derivative instruments recorded on the balance sheet		$	82,130	$	(152,277	)	$	9,474	$	(60,673	)

The following table presents the fair values and locations of derivative instruments recorded on the Condensed Consolidated Balance Sheet as of December 31, 2011 (in thousands):


		Fair Value
Derivative	Balance Sheet Location	Asset		Liability			Net Asset (Liability)
Foreign currency contracts	Other current assets	$	32	$	—		$	32
Interest rate contracts	Other current liabilities		—		(16,253	)		(16,253	)
Interest rate contracts	Other non-current liabilities and deferred credits		—		(2,642	)		(2,642	)
Commodity contracts	Current utility energy commodity derivative assets		1,618		(479	)		1,139
Commodity contracts	Non-current utility energy commodity derivative assets		185		—			185
Commodity contracts	Current utility energy commodity derivative liabilities		40,090		(110,914	)		(70,824	)
Commodity contracts	Other non-current liabilities and deferred credits		44,308		(84,838	)		(40,530	)

Total derivative instruments recorded on the balance sheet		$	86,233	$	(215,126	)	$	(128,893	)

Exposure to Demands for Collateral

The Company’s derivative contracts often require collateral (in the form of cash or letters of credit) or other credit enhancements, or reductions or terminations of a portion of the contract through cash settlement, in the event of a downgrade in the Company’s credit ratings or changes in market prices. In periods of price volatility, the level of exposure can change significantly. As a result, sudden and significant demands may be made against the Company’s credit facilities and cash. The Company actively monitors the exposure to possible collateral calls and takes steps to mitigate capital requirements. As of September 30, 2012, the Company had cash deposited as collateral of $15.0 million and letters of credit of $19.3 million outstanding related to its energy derivative contracts. The Consolidated Balance Sheet at September 30, 2012 reflects the offsetting of $9.5 million of cash collateral against net derivative positions where a legal right of offset exists.

AVISTA CORPORATION

Certain of the Company’s derivative instruments contain provisions that require the Company to maintain an investment grade credit rating from the major credit rating agencies. If the Company’s credit ratings were to fall below “investment grade,” it would be in violation of these provisions, and the counterparties to the derivative instruments could request immediate payment or demand immediate and ongoing collateralization on derivative instruments in net liability positions. The aggregate fair value of all derivative instruments with credit-risk-related contingent features that are in a liability position as of September 30, 2012 was $115.8 million. If the credit-risk-related contingent features underlying these agreements were triggered on September 30, 2012, the Company could be required to post $32.5 million of additional collateral to its counterparties.

Credit Risk

Credit risk relates to the potential losses that the Company would incur as a result of non-performance by counterparties of their contractual obligations to deliver energy or make financial settlements. The Company often extends credit to counterparties and customers and is exposed to the risk that it may not be able to collect amounts owed to the Company. Credit risk includes potential counterparty default due to circumstances:

•

relating directly to it,

•

caused by market price changes, and

•

relating to other market participants that have a direct or indirect relationship with such counterparty.

Changes in market prices may dramatically alter the size of credit risk with counterparties, even when conservative credit limits are established. Should a counterparty fail to perform, the Company may be required to honor the underlying commitment or to replace existing contracts with contracts at then-current market prices. The Company seeks to mitigate credit risk by:

•

entering into bilateral contracts that specify credit terms and protections against default,

•

applying credit limits and duration criteria to existing and prospective counterparties,

•

actively monitoring current credit exposures, and

•

conducting transactions on exchanges with fully collateralized clearing arrangements that significantly reduce counterparty default risk.

The Company’s credit policy includes an evaluation of the financial condition of counterparties. Credit risk management includes collateral requirements or other credit enhancements, such as letters of credit or parent company guarantees. The Company enters into various agreements that address credit risks including standardized agreements that allow for the netting or offsetting of positive and negative exposures.

The Company has concentrations of suppliers and customers in the electric and natural gas industries including:

•

electric and natural gas utilities,

•

electric generators and transmission providers,

•

natural gas producers and pipelines,

•

financial institutions including commodity clearing exchanges and related parties, and

•

energy marketing and trading companies.

In addition, the Company has concentrations of credit risk related to geographic location as it operates in the western United States and western Canada. These concentrations of counterparties and concentrations of geographic location may impact the Company’s overall exposure to credit risk because the counterparties may be similarly affected by changes in conditions.

The Company maintains credit support agreements with certain counterparties and margin calls are periodically made and/or received. Margin calls are triggered when exposures exceed contractual limits or when there are changes in a counterparty’s creditworthiness. Price movements in electricity and natural gas can generate exposure levels in excess of these contractual limits. Negotiating for collateral in the form of cash, letters of credit, or performance guarantees is common industry practice.

NOTE 6. PENSION PLANS AND OTHER POSTRETIREMENT BENEFIT PLANS

The Company has a defined benefit pension plan covering substantially all regular full-time employees at Avista Utilities. Individual benefits under this plan are based upon the employee’s years of service, date of hire and average compensation as specified in the plan. The Company’s funding policy is to contribute at least the minimum amounts that are required to be funded under the Employee Retirement Income Security Act, but not more than the maximum amounts that are currently deductible for income tax purposes. The Company contributed $26 million in cash to the pension plan in 2011. The Company contributed $44 million in cash to the pension plan in 2012 (with no further contributions planned for the remainder of 2012).

AVISTA CORPORATION

The Company also has a Supplemental Executive Retirement Plan (SERP) that provides additional pension benefits to executive officers of the Company. The SERP is intended to provide benefits to executive officers whose benefits under the pension plan are reduced due to the application of Section 415 of the Internal Revenue Code of 1986 and the deferral of salary under deferred compensation plans. The liability and expense for this plan are included as pension benefits in the tables included in this Note.

The Company provides certain health care and life insurance benefits for substantially all of its retired employees. The Company accrues the estimated cost of postretirement benefit obligations during the years that employees provide services.

The Company has a Health Reimbursement Arrangement to provide employees with tax-advantaged funds to pay for allowable medical expenses upon retirement. The amount earned by the employee is fixed on the retirement date based on the employee’s years of service and the ending salary. The liability and expense of this plan are included as other postretirement benefits.

The Company provides death benefits to beneficiaries of executive officers who die during their term of office or after retirement. Under the plan, an executive officer’s designated beneficiary will receive a payment equal to twice the executive officer’s annual base salary at the time of death (or if death occurs after retirement, a payment equal to twice the executive officer’s total annual pension benefit). The liability and expense for this plan are included as other postretirement benefits.

The Company uses a December 31 measurement date for its pension and other postretirement benefit plans. The following table sets forth the components of net periodic benefit costs for the three and nine months ended September 30 (dollars in thousands):


	Pension Benefits						Other Post- retirement Benefits
	2012			2011			2012			2011
Three months ended September 30:
Service cost	$	3,891		$	3,303		$	689		$	433
Interest cost		6,084			6,017			1,256			1,005
Expected return on plan assets		(5,950	)		(5,775	)		(375	)		(400	)
Transition obligation recognition		—			—			125			125
Amortization of prior service cost		75			125			(37	)		(37	)
Net loss recognition		3,019			2,506			1,250			960

Net periodic benefit cost	$	7,119		$	6,176		$	2,908		$	2,086

Nine months ended September 30:
Service cost	$	11,573		$	9,548		$	2,067		$	1,299
Interest cost		18,277			18,143			3,793			3,015
Expected return on plan assets		(17,900	)		(17,141	)		(1,125	)		(1,200	)
Transition obligation recognition		—			—			375			375
Amortization of prior service cost		225			369			(111	)		(111	)
Net loss recognition		8,797			6,909			3,814			2,634

Net periodic benefit cost	$	20,972		$	17,828		$	8,813		$	6,012

NOTE 7. SHORT-TERM BORROWINGS

Avista Corp.

Avista Corp. has a committed line of credit with various financial institutions in the total amount of $400.0 million with an expiration date of February 2017. The committed line of credit is secured by non-transferable First Mortgage Bonds of the Company issued to the agent bank that would only become due and payable in the event, and then only to the extent, that the Company defaults on its obligations under the committed line of credit.

The committed line of credit agreement contains customary covenants and default provisions. The credit agreement has a covenant which does not permit the ratio of “consolidated total debt” to “consolidated total capitalization” of Avista Corp. to be greater than 65 percent at any time. As of September 30, 2012, the Company was in compliance with this covenant.

AVISTA CORPORATION

Balances outstanding and interest rates of borrowings (excluding letters of credit) under the Company’s revolving committed lines of credit were as follows as of September 30, 2012 and December 31, 2011 (dollars in thousands):


	September 30,			December 31,
	2012			2011
Balance outstanding at end of period	$	82,000		$	61,000
Letters of credit outstanding at end of period	$	26,815		$	29,030
Average interest rate at end of period		1.08	%		1.12	%

Ecova

In July 2012, Ecova entered into a new $125.0 million committed line of credit agreement with various financial institutions that replaced its $60.0 million committed line of credit agreement and has an expiration date of July 2017. The credit agreement is secured by substantially all of Ecova’s assets. Balances outstanding and interest rates of borrowings under Ecova’s credit agreements were as follows as of September 30, 2012 and December 31, 2011 (dollars in thousands):


	September 30,			December 31,
	2012			2011
Balance outstanding at end of period	$	58,000		$	35,000
Average interest rate at end of period		2.49	%		2.38	%

As of September 30, 2012, borrowings under Ecova’s committed line of credit were classified as long-term.

NOTE 8. LONG-TERM DEBT

The following details long-term debt outstanding as of September 30, 2012 and December 31, 2011 (dollars in thousands):


Maturity Year	Description	Interest Rate	September 30, 2012			December 31, 2011
2012	Secured Medium-Term Notes	7.37%	$	—		$	7,000
2013	First Mortgage Bonds	1.68%		50,000			50,000
2018	First Mortgage Bonds	5.95%		250,000			250,000
2018	Secured Medium-Term Notes	7.39%-7.45%		22,500			22,500
2019	First Mortgage Bonds	5.45%		90,000			90,000
2020	First Mortgage Bonds	3.89%		52,000			52,000
2022	First Mortgage Bonds	5.13%		250,000			250,000
2023	Secured Medium-Term Notes	7.18%-7.54%		13,500			13,500
2028	Secured Medium-Term Notes	6.37%		25,000			25,000
2032	Secured Pollution Control Bonds (1)	(1)		66,700			66,700
2034	Secured Pollution Control Bonds (2)	(2)		17,000			17,000
2035	First Mortgage Bonds	6.25%		150,000			150,000
2037	First Mortgage Bonds	5.70%		150,000			150,000
2040	First Mortgage Bonds	5.55%		35,000			35,000
2041	First Mortgage Bonds	4.45%		85,000			85,000

	Total secured long-term debt			1,256,700			1,263,700
2023	Unsecured Pollution Control Bonds	6.00%		—			4,100
	Other long-term debt and capital leases			5,192			5,455
	Settled interest rate swaps			(28,252	)		(10,629	)
	Unamortized debt discount			(1,501	)		(1,626	)

	Total			1,232,139			1,261,000
	Secured Pollution Control Bonds held by Avista Corporation (1) (2)			(83,700	)		(83,700	)
	Current portion of long-term debt			(392	)		(7,474	)

	Total long-term debt		$	1,148,047		$	1,169,826

(1)

In December 2010, $66.7 million of the City of Forsyth, Montana Pollution Control Revenue Refunding Bonds (Avista Corporation Colstrip Project) due 2032, which had been held by Avista Corp. since 2008, were refunded by a new bond issue (Series 2010A). The new bonds were not offered to the public and were purchased by Avista Corp. due to market conditions. The Company expects that at a later date, subject to market conditions, these bonds may be remarketed to unaffiliated investors. So long as Avista Corp. is the holder of these bonds, the bonds will not be reflected as an asset or a liability on Avista Corp.’s Condensed Consolidated Balance Sheet.

AVISTA CORPORATION

(2)

In December 2010, $17.0 million of the City of Forsyth, Montana Pollution Control Revenue Refunding Bonds, (Avista Corporation Colstrip Project) due 2034, which had been held by Avista Corp. since 2009, were refunded by a new bond issue (Series 2010B). The new bonds were not offered to the public and were purchased by Avista Corp. due to market conditions. The Company expects that at a later date, subject to market conditions, the bonds may be remarketed to unaffiliated investors. So long as Avista Corp. is the holder of these bonds, the bonds will not be reflected as an asset or a liability on Avista Corp.’s Condensed Consolidated Balance Sheet.

In June 2012, Avista Corp. 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. The new First Mortgage Bonds will be issued under and in accordance with the Mortgage and Deed of Trust, dated as of June 1, 1939, from the Company to Citibank, N.A., trustee, as amended and supplemented by various supplemental indentures and other instruments. 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 the Company’s $400.0 million committed line of credit and for general corporate purposes.

Nonrecourse Long-Term Debt

Nonrecourse long-term debt (including current portion) represents the long-term debt of Spokane Energy. To provide funding to acquire a long-term fixed rate electric capacity contract from Avista Corp., Spokane Energy borrowed $145.0 million from a funding trust in December 1998. The long-term debt has scheduled monthly installments and interest at a fixed rate of 8.45 percent with the final payment due in January 2015. Spokane Energy bears full recourse risk for the debt, which is secured by the fixed rate electric capacity contract and $1.6 million of funds held in a trust account.

NOTE 9. FAIR VALUE

The carrying values of cash and cash equivalents, accounts and notes receivable, accounts payable and short-term borrowings are reasonable estimates of their fair values. Long-term debt (including current portion, but excluding capital leases), nonrecourse long-term debt and long-term debt to affiliated trusts are reported at carrying value on the Condensed Consolidated Balance Sheets.

The fair value hierarchy prioritizes the inputs used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement).

The three levels of the fair value hierarchy are defined as follows:

Level 1 – Quoted prices are available in active markets for identical assets or liabilities. Active markets are those in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis.

Level 2 – Pricing inputs are other than quoted prices in active markets included in Level 1, which are either directly or indirectly observable as of the reporting date. Level 2 includes those financial instruments that are valued using models or other valuation methodologies. These models are primarily industry-standard models that consider various assumptions, including quoted forward prices for commodities, time value, volatility factors, and current market and contractual prices for the underlying instruments, as well as other relevant economic measures. Substantially all of these assumptions are observable in the marketplace throughout the full term of the instrument, can be derived from observable data or are supported by observable levels at which transactions are executed in the marketplace.

Level 3 – Pricing inputs include significant inputs that are generally unobservable from objective sources. These inputs may be used with internally developed methodologies that result in management’s best estimate of fair value.

Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement requires judgment, and may affect the valuation of fair value assets and liabilities and their placement within the fair value hierarchy levels. The determination of the fair values incorporates various factors that not only include the credit standing of the counterparties involved and the impact of credit enhancements (such as cash deposits and letters of credit), but also the impact of Avista Corp.’s nonperformance risk on its liabilities.

AVISTA CORPORATION

The following table sets forth the carrying value and estimated fair value of the Company’s financial instruments not reported at estimated fair value on the Condensed Consolidated Balance Sheets as of September 30, 2012 and December 31, 2011 (dollars in thousands):


	September 30, 2012				December 31, 2011
	Carrying Value		Estimated Fair Value		Carrying Value		Estimated Fair Value
Long-term debt (Level 2)	$	951,000	$	1,164,223	$	962,100	$	1,135,536
Long-term debt (Level 3)		222,000		245,995		222,000		234,226
Nonrecourse long-term debt (Level 3)		36,319		39,336		46,471		51,974
Long-term debt to affiliated trusts (Level 3)		51,547		43,686		51,547		43,810

These estimates of fair value of long-term debt and long-term debt to affiliated trusts were primarily based on available market information. The Company’s publicly held long-term debt was classified as Level 2, as the fair value was determined utilizing observable inputs in non-active markets. The Company’s other long-term debt (including long-term debt to affiliated trusts and nonrecourse long-term debt) was classified as Level 3, as certain inputs used to determine the fair value are unobservable. In particular, due to the unique nature of the long-term fixed rate electric capacity contract securing the long-term debt of Spokane Energy (nonrecourse long-term debt), the estimated fair value of nonrecourse long-term debt was determined based on a discounted cash flow model using available market information.

The following table discloses by level within the fair value hierarchy the Company’s assets and liabilities measured and reported on the Condensed Consolidated Balance Sheets as of September 30, 2012 and December 31, 2011 at fair value on a recurring basis (dollars in thousands):


	Level 1		Level 2		Level 3		Counterparty and Cash Collateral Netting (1)			Total
September 30, 2012
Assets:
Energy commodity derivatives	$	—	$	76,695	$	—	$	(73,944	)	$	2,751
Level 3 energy commodity derivatives:
Power exchange agreements		—		—		366		(366	)		—
Interest rate swaps		—		5,069		—		—			5,069
Investments and funds held for clients:
Cash and cash equivalents		31,874		—		—		—			31,874
Securities available for sale:
U.S. government agency		—		63,458		—		—			63,458
Municipal		—		5,182		—		—			5,182
Corporate fixed income – financial		—		6,634		—		—			6,634
Corporate fixed income – industrial		—		4,999		—		—			4,999
Corporate fixed income – utility		—		1,068		—		—			1,068
Certificate of deposits		—		1,011		—		—			1,011
Funds held in trust account of Spokane Energy		1,600		—		—		—			1,600
Deferred compensation assets:
Fixed income securities (2)		2,148		—		—		—			2,148
Equity securities (2)		5,814		—		—		—			5,814

Total	$	41,436	$	164,116	$	366	$	(74,310	)	$	131,608

Liabilities:
Energy commodity derivatives	$	—	$	125,488	$	—	$	(83,418	)	$	42,070
Level 3 energy commodity derivatives:
Natural gas exchange agreements		—		—		3,105		—			3,105
Power exchange agreements		—		—		18,242		(366	)		17,876
Power option agreements		—		—		1,585		—			1,585
Interest rate swaps		—		3,827		—		—			3,827
Foreign currency derivatives		—		30		—		—			30

Total	$	—	$	129,345	$	22,932	$	(83,784	)	$	68,493

AVISTA CORPORATION


	Level 1		Level 2		Level 3		Counterparty and Cash Collateral Netting (1)			Total
December 31, 2011
Assets:
Energy commodity derivatives	$	—	$	80,571	$	—	$	(79,247	)	$	1,324
Level 3 energy commodity derivatives:
Natural gas exchange agreements		—		—		956		(956	)		—
Power exchange agreements		—		—		4,674		(4,674	)		—
Foreign currency derivatives		—		32		—		—			32
Investments and funds held for clients:
Cash and cash equivalents		21,957		—		—		—			21,957
Securities available for sale:
U.S. government agency		—		74,893		—		—			74,893
Municipal		—		425		—		—			425
Corporate fixed income – financial		—		11,154		—		—			11,154
Corporate fixed income – industrial		—		6,518		—		—			6,518
Corporate fixed income – utility		—		2,092		—		—			2,092
Certificate of deposits		—		1,497		—		—			1,497
Funds held in trust account of Spokane Energy		1,600		—		—		—			1,600
Deferred compensation assets:
Fixed income securities (2)		2,116		—		—		—			2,116
Equity securities (2)		5,252		—		—		—			5,252

Total	$	30,925	$	177,182	$	5,630	$	(84,877	)	$	128,860

Liabilities:
Energy commodity derivatives	$	—	$	177,743	$	—	$	(79,247	)	$	98,496
Level 3 energy commodity derivatives:
Natural gas exchange agreements		—		—		2,644		(956	)		1,688
Power exchange agreements		—		—		14,584		(4,674	)		9,910
Power option agreements		—		—		1,260		—			1,260
Interest rate swaps		—		18,895		—		—			18,895

Total	$	—	$	196,638	$	18,488	$	(84,877	)	$	130,249

(1)

The Company is permitted to net derivative assets and derivative liabilities with the same counterparty when a legally enforceable master netting agreement exists. In addition, the Company nets derivative assets and derivative liabilities against any payables and receivables for cash collateral held or placed with these same counterparties.

(2)	These assets are trading securities and are included in other intangibles, property and investments-net on the Condensed Consolidated Balance Sheets.

Avista Utilities enters into forward contracts to purchase or sell a specified amount of energy at a specified time, or during a specified period, in the future. These contracts are entered into as part of Avista Utilities’ management of loads and resources and certain contracts are considered derivative instruments. The difference between the amount of derivative assets and liabilities disclosed in respective levels and the amount of derivative assets and liabilities disclosed on the Condensed Consolidated Balance Sheets is due to netting arrangements with certain counterparties. The Company uses quoted market prices and forward price curves to estimate the fair value of utility derivative commodity instruments included in Level 2. In particular, electric derivative valuations are performed using broker quotes, adjusted for periods in between quotable periods. Natural gas derivative valuations are estimated using New York Mercantile Exchange (NYMEX) pricing for similar instruments, adjusted for basin differences, using broker quotes. Where observable inputs are available for substantially the full term of the contract, the derivative asset or liability is included in Level 2.

For securities available for sale (held at Ecova) the Company uses a nationally recognized third party to obtain fair value and reviews these prices for accuracy using a variety of market tools and analysis. The Company’s pricing vendor uses a generic model which uses standard inputs (listed in order of priority for use), including benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, market bids/offers and other reference data. The pricing vendor also monitors market indicators, as well as industry and economic events. Further, the model uses Option Adjusted Spread and is a multidimensional relational model. All securities available for sale were deemed Level 2.

AVISTA CORPORATION

Deferred compensation assets and liabilities represent funds held by the Company in a Rabbi Trust for an executive deferral plan. These funds consist of actively traded equity and bond funds with quoted prices in active markets. The balance disclosed in the table above excludes cash and cash equivalents of $0.9 million as of September 30, 2012 and $1.3 million as of December 31, 2011.

Level 3 Fair Value

For power exchange agreements, the Company compares the Level 2 brokered quotes and forward price curves described above to an internally developed forward price which is based on the average operating and maintenance (O&M) charges from four surrogate nuclear power plants around the country for the current year. Because the nuclear power plant O&M charges are only known for one year, all forward years are estimated assuming an annual escalation. In addition to the forward price being estimated using unobservable inputs, the Company also estimates the volumes of the transactions that will take place in the future based on historical average transaction volumes per delivery year (November to April). Significant increases or decreases in any of these inputs in isolation would result in a significantly higher or lower fair value measurement. Generally, a change in the current year O&M charges for the surrogate plants is accompanied by a directionally similar change in O&M charges in future years. There is generally not a correlation between external market prices and the O&M charges used to develop the internal forward price.

For power commodity option agreements, the Company uses the Black-Scholes-Merton valuation model to estimate the fair value, and this model includes significant inputs not observable or corroborated in the market. These inputs include 1) the strike price (which is an internally derived price based on a combination of generation plant heat rate factors, natural gas market pricing, delivery and other O&M charges, 2) estimated delivery volumes for years beyond 2012, and 3) volatility rates for periods beyond October 2015. Significant increases or decreases in any of these inputs in isolation would result in a significantly higher or lower fair value measurement. Generally, changes in overall commodity market prices and volatility rates are accompanied by directionally similar changes in the strike price and volatility assumptions used in the calculation.

For natural gas commodity exchange agreements, the Company uses the same Level 2 brokered quotes described above; however, the Company also estimates the purchase and sales volumes (within contractual limits) as well as the timing of those transactions. Changing the timing of volume estimates changes the timing of purchases and sales, impacting which brokered quote is used. Because the brokered quotes can vary significantly from period to period, the unobservable estimates of the timing and volume of transactions can have a significant impact on the calculated fair value. The Company currently estimates volumes and timing of transactions based on a most likely scenario using historical data. Historically, the timing and volume of transactions have not been highly correlated with market prices and market volatility.

The following table presents the quantitative information which was used to estimate the fair values of the Level 3 assets and liabilities above as of September 30, 2012 (dollars in thousands):


	Fair Value (Net) at September 30, 2012			Valuation Technique	Unobservable Input	Range
Power exchange agreements	$	(17,876	)	Surrogate facility pricing	O&M charges	$30.49 - $53.82/MWh (1)
Power exchange agreements				Surrogate facility pricing	Escalation factor	5% - 2012 to 2015
						3% - 2016 to 2019
					Transaction volumes	361,630 - 379,156 MWhs

Power option agreements		(1,585	)	Black-Scholes-Merton	Strike price	$41.84/MWh - 2012
				Black-Scholes-Merton		$78.21/MWh - 2019
					Delivery volumes	157,517 - 287,147 MWhs
					Volatility rates	0.20 (2)

Natural gas exchange agreements		(3,105	)	Internally derived weighted average cost of gas	Forward purchase prices	$3.53 - $3.69/mmBTU
Natural gas exchange agreements					Forward sales prices	$3.70 - $4.65/mmBTU
					Purchase volumes	135,000 - 465,000 mmBTUs
					Sales volumes	140,010 - 310,000 mmBTUs

(1)	The average O&M charges for 2012 were $40.87 per MWh.

(2)	The estimated volatility rate of 0.20 is compared to actual known volatility rates of 0.34 for 2012 to 0.24 in October 2015.

AVISTA CORPORATION

Avista Corp.’s risk management team and accounting team are responsible for developing the valuation methods described above and both groups report to the Chief Financial Officer. The valuation methods, the significant inputs, and the resulting fair values described above are reviewed on at least a quarterly basis by the risk management team and the accounting team to ensure they provide a reasonable estimate of fair value each reporting period.

The following table presents activity for net energy commodity derivative assets (liabilities) measured at fair value using significant unobservable inputs (Level 3) for the three and nine months ended September 30, 2012 and 2011 (dollars in thousands):


	Natural Gas Exchange Agreements			Power Exchange Agreements			Power Option Agreements			Total


Three months ended September 30, 2012:
Balance as of July 1, 2012	$	(2,727	)	$	(10,438	)	$	(1,756	)	$	(14,921	)
Total gains or losses (realized/unrealized):
Included in net income		—			—			—			—
Included in other comprehensive income		—			—			—			—
Included in regulatory assets/liabilities (1)		(377	)		(7,438	)		171			(7,644	)
Purchases		—			—			—			—
Issuances		—			—			—			—
Settlements		(1	)		—			—			(1	)
Transfers to other categories		—			—			—			—

Ending balance as of September 30, 2012	$	(3,105	)	$	(17,876	)	$	(1,585	)	$	(22,566	)

Nine months ended September 30, 2012:
Balance as of January 1, 2012	$	(1,688	)	$	(9,910	)	$	(1,260	)	$	(12,858	)
Total gains or losses (realized/unrealized):
Included in net income		—			—			—			—
Included in other comprehensive income		—			—			—			—
Included in regulatory assets/liabilities (1)		(364	)		(12,216	)		(325	)		(12,905	)
Purchases		—			—			—			—
Issuances		—			—			—			—
Settlements		(1,053	)		4,250			—			3,197
Transfers to other categories		—			—			—			—

Ending balance as of September 30, 2012	$	(3,105	)	$	(17,876	)	$	(1,585	)	$	(22,566	)

Three months ended September 30, 2011:
Balance as of July 1, 2011	$	(4,404	)	$	13,058		$	(1,309	)	$	7,345
Total gains or losses (realized/unrealized):
Included in net income		—			—			—			—
Included in other comprehensive income		—			—			—			—
Included in regulatory assets/liabilities (1)		2,138			(8,962	)		(281	)		(7,105	)
Purchases		—			—			—			—
Issuances		—			—			—			—
Settlements		—			—			—			—
Transfers to other categories		—			—			—			—

Ending balance as of September 30, 2011	$	(2,266	)	$	4,096		$	(1,590	)	$	240

Nine months ended September 30, 2011:
Balance as of January 1, 2011	$	—		$	15,793		$	(2,334	)	$	13,459
Total gains or losses (realized/unrealized):
Included in net income		—			—			—			—
Included in other comprehensive income		—			—			—			—
Included in regulatory assets/liabilities (1)		2,138			(13,642	)		744			(10,760	)
Purchases		—			—			—			—
Issuances		—			—			—			—
Settlements		—			1,945			—			1,945
Transfers to other categories		(4,404	)		—			—			(4,404	)

Ending balance as of September 30, 2011	$	(2,266	)	$	4,096		$	(1,590	)	$	240

(1)

The WUTC and the IPUC issued accounting orders authorizing Avista Utilities to offset commodity derivative assets or liabilities with a regulatory asset or liability. This accounting treatment is intended to defer the recognition of mark-to-market gains and losses on energy commodity transactions until the period of settlement. The orders provide for Avista Utilities to not recognize the unrealized gain or loss on utility derivative commodity instruments in the Condensed Consolidated Statements of Income. Realized gains or losses are recognized in the period of settlement, subject to approval for recovery through retail rates. Realized gains and losses, subject to regulatory approval, result in adjustments to retail rates through purchased gas cost adjustments, the ERM in Washington, the PCA mechanism in Idaho, and periodic general rates cases.

AVISTA CORPORATION

NOTE 10. EARNINGS PER COMMON SHARE ATTRIBUTABLE TO AVISTA CORPORATION

The following table presents the computation of basic and diluted earnings per common share attributable to Avista Corporation for the three and nine months ended September 30 (in thousands, except per share amounts):


	Three months ended						Nine months ended
	September 30,						September 30,
	2012			2011			2012			2011
Numerator:
Net income attributable to Avista Corporation	$	5,786		$	10,702		$	62,352		$	75,621
Noncontrolling earnings adjustment for dilutive securities		(16	)		(170	)		(25	)		(340	)

Adjusted net income attributable to Avista Corporation for computation of diluted earnings per common share	$	5,770		$	10,532		$	62,327		$	75,281

Denominator:
Weighted-average number of common shares outstanding-basic		59,047			58,057			58,778			57,731
Effect of dilutive securities:
Performance and restricted stock awards		71			131			234			149
Stock options		5			44			14			54

Weighted-average number of common shares outstanding-diluted		59,123			58,232			59,026			57,934

Earnings per common share attributable to Avista Corporation:
Basic	$	0.10		$	0.18		$	1.06		$	1.31


Diluted	$	0.10		$	0.18		$	1.06		$	1.30

NOTE 11. COMMITMENTS AND CONTINGENCIES

In the course of its business, the Company becomes involved in various claims, controversies, disputes and other contingent matters, including the items described in this Note. Some of these claims, controversies, disputes and other contingent matters involve litigation or other contested proceedings. For all such matters, the Company intends to vigorously protect and defend its interests and pursue its rights. However, no assurance can be given as to the ultimate outcome of any particular matter because litigation and other contested proceedings are inherently subject to numerous uncertainties. For matters that affect Avista Utilities’ operations, the Company intends to seek, to the extent appropriate, recovery of incurred costs through the ratemaking process. With respect to matters discussed in this Note relating to Avista Energy, any potential liabilities or refunds by Avista Energy remain the responsibility of Avista Corp. and/or its subsidiaries and were not assumed by the purchaser of Avista Energy’s contracts and operations in 2007.

Federal Energy Regulatory Commission Inquiry

In April 2004, the Federal Energy Regulatory Commission (FERC) approved the contested Agreement in Resolution of Section 206 Proceeding (Agreement in Resolution) between Avista Corp. doing business as Avista Utilities, Avista Energy and the FERC’s Trial Staff which stated that there was: (1) no evidence that any executives or employees of Avista Utilities or Avista Energy knowingly engaged in or facilitated any improper trading strategy during 2000 and 2001; (2) no evidence that Avista Utilities or Avista Energy engaged in any efforts to manipulate the western energy markets during 2000 and 2001; and (3) no finding that Avista Utilities or Avista Energy withheld relevant information from the FERC’s inquiry into the western energy markets for 2000 and 2001 (Trading Investigation). The Attorney General of the State of California (California AG), the California Electricity Oversight Board, and the City of Tacoma, Washington (City of Tacoma) challenged the FERC’s decisions approving the Agreement in Resolution, which are now pending before the United States Court of Appeals for the Ninth Circuit (Ninth Circuit).

AVISTA CORPORATION

In May 2004, the FERC provided notice that Avista Energy was no longer subject to an investigation reviewing certain bids above $250 per MW in the short-term energy markets operated by the California Independent System Operator (CalISO) and the California Power Exchange (CalPX) from May 1, 2000 to October 2, 2000 (Bidding Investigation). That matter is also pending before the Ninth Circuit, after the California AG, Pacific Gas & Electric (PG&E), Southern California Edison Company (SCE) and the California Public Utilities Commission (CPUC) filed petitions for review in 2005.

Based on the FERC’s order approving the Agreement in Resolution in the Trading Investigation and order denying rehearing requests, the Company does not expect that this proceeding will have any material effect on its financial condition, results of operations or cash flows. Furthermore, based on information currently known to the Company regarding the Bidding Investigation and the fact that the FERC Staff did not find any evidence of manipulative behavior, the Company does not expect that this matter will have a material effect on its financial condition, results of operations or cash flows.

California Refund Proceeding

In July 2001, the FERC ordered an evidentiary hearing to determine the amount of refunds due to California energy buyers for purchases made in the spot markets operated by the CalISO and the CalPX during the period from October 2, 2000 to June 20, 2001 (Refund Period). Proposed refunds are based on the calculation of mitigated market clearing prices for each hour. The FERC ruled that if the refunds required by the formula would cause a seller to recover less than its actual costs for the Refund Period, sellers may document these costs and limit their refund liability commensurately. In September 2005, Avista Energy submitted its cost filing claim pursuant to the FERC’s August 2005 order. The filing was initially accepted by the FERC, but in March 2011, the FERC ordered Avista Energy to remove any return on equity in a compliance filing with the CalISO, which Avista Energy did in April 2011. A challenge to Avista Energy’s cost filing by the California AG, the CPUC, PG&E and SCE was denied in July 2011 as a collateral attack on the FERC’s prior orders accepting Avista Energy’s cost filing. In July 2011, the California AG, the CPUC, PG&E and SCE filed a petition for review of the FERC’s orders regarding Avista Energy’s cost filing with the Ninth Circuit.

The 2001 bankruptcy of PG&E resulted in a default on its payment obligations to the CalPX. As a result, Avista Energy has not been paid for all of its energy sales during the Refund Period. Those funds are now in escrow accounts and will not be released until the FERC issues an order directing such release in the California refund proceeding. The CalISO continues to work on its compliance filing for the Refund Period, which will show “who owes what to whom.” In July 2011, the FERC accepted the preparatory rerun compliance filings by the CalPX and CalISO, and responded to the CalPX request for guidance on issues related to completing the final determination of “who owes what to whom.” The FERC directed both the CalISO and the CalPX to prepare and submit to the FERC their final refund rerun compliance filings. The FERC’s order also directs the CalPX to pay past due principal amounts to governmental entities. In February 2012, the FERC denied the challenges made to the July 2011 order by the California AG, the CPUC, PG&E and SCE. As of September 30, 2012, Avista Energy’s accounts receivable outstanding related to defaulting parties in California were fully offset by reserves for uncollected amounts and funds collected from the defaulting parties.

Many of the orders that the FERC has issued in the California refund proceedings were appealed to the Ninth Circuit. In October 2004, the Ninth Circuit ordered that briefing proceed in two rounds. The first round was limited to three issues: (1) which parties are subject to the FERC’s refund jurisdiction in light of the exemption for government-owned utilities in section 201(f) of the FPA; (2) the temporal scope of refunds under section 206 of the FPA; and (3) which categories of transactions are subject to refunds. The second round of issues and their corresponding briefing schedules have not yet been set by the Ninth Circuit.

In September 2005, the Ninth Circuit held that the FERC did not have the authority to order refunds for sales made by municipal utilities in the California refund proceeding. In August 2006, the Ninth Circuit upheld October 2, 2000 as the refund effective date for the FPA section 206 refund proceeding, but remanded to the FERC its decision not to consider an FPA section 309 remedy for tariff violations prior to that date. In an order issued in May 2011, the FERC clarified the issues set for hearing for the period May 1, 2000 – October 1, 2000 (Summer Period): (1) which market practices and behaviors constitute a violation of the then-current CalISO, CalPX, and individual seller’s tariffs and FERC orders; (2) whether any of the sellers named as respondents in this proceeding engaged in those tariff violations; and (3) whether any such tariff violations affected the market clearing price. The FERC reiterated that the California Parties are expected to be very specific when presenting their arguments and evidence, and that general claims would not suffice. The FERC also gave the California Parties an opportunity to show that exchange transactions with the CalISO during the Refund Period were not just and reasonable. Avista Energy has one exchange transaction with the CalISO. The California AG, the CPUC, PG&E and SCE filed for rehearing of the FERC’s May 2011 order, arguing that it improperly denies them a market-wide remedy for the pre-refund period. That request for rehearing was denied in an order issued by FERC on November 2, 2012. The California AG, the CPUC, PG&E and SCE also filed a petition for review of the May 2011 order with the Ninth Circuit. A FERC hearing commenced on April 11, 2012 and concluded on July 19, 2012. Post-hearing briefs were filed September 28, 2012, and reply briefs are due December 4, 2012. The initial decision is to be issued no later than February 15, 2013. On August 27, 2012, the Presiding Administrative Law Judge issued a partial initial decision granting Avista Utilities’ motion for summary disposition, based on the stipulation by the California Parties that there are no allegations of tariff violations made against Avista Utilities in this proceeding and therefore no tariff violations by Avista Utilities that affected the market clearing price in any hour during the Summer Period. The California Parties filed a brief on exceptions on September 26, 2012, and Avista Utilities filed a brief opposing exceptions on October 16, 2012. On November 2, 2012, FERC issued an order affirming the partial initial decision and dismissing Avista Utilities from the proceeding, thereby terminating all claims against Avista Utilities for the Summer Period. In the same order, FERC also held that a market-wide remedy would not be appropriate with regard to any respondent during the Summer Period. FERC stated that it is clear that the Ninth Circuit did not mandate a specific remedy on remand and, instead, left it to the FERC’s discretion to determine which remedy would be appropriate.

AVISTA CORPORATION

Because the resolution of the California refund proceeding remains uncertain, legal counsel cannot express an opinion on the extent of the Company’s liability, if any. However, based on information currently known, the Company does not expect that the refunds ultimately ordered for the Refund Period would result in a material loss. This is primarily due to the fact that the FERC orders have stated that any refunds will be netted against unpaid amounts owed to the respective parties and the Company does not believe that refunds would exceed unpaid amounts owed to the Company.

Pacific Northwest Refund Proceeding

In July 2001, the FERC initiated a preliminary evidentiary hearing to develop a factual record as to whether prices for spot market sales of wholesale energy in the Pacific Northwest between December 25, 2000 and June 20, 2001 were just and reasonable. In June 2003, the FERC terminated the Pacific Northwest refund proceedings, after finding that the equities do not justify the imposition of refunds. In August 2007, the Ninth Circuit found that the FERC, in denying the request for refunds, had failed to take into account new evidence of market manipulation in the California energy market and its potential ties to the Pacific Northwest energy market and that such failure was arbitrary and capricious and, accordingly, remanded the case to the FERC, stating that the FERC’s findings must be reevaluated in light of the evidence. In addition, the Ninth Circuit concluded that the FERC abused its discretion in denying potential relief for transactions involving energy that was purchased by the California Energy Resources Scheduling (CERS) in the Pacific Northwest and ultimately consumed in California. The Ninth Circuit expressly declined to direct the FERC to grant refunds. The Ninth Circuit denied petitions for rehearing by various parties, and remanded the case to the FERC in April 2009.

On October 3, 2011, the FERC issued an Order on Remand, finding that, in light of the Ninth Circuit’s remand order, additional procedures are needed to address possible unlawful activity that may have influenced prices in the Pacific Northwest spot market during the period from December 25, 2000 through June 20, 2001. The Order establishes an evidentiary, trial-type hearing before an Administrative Law Judge (ALJ), and reopens the record to permit parties to present evidence of unlawful market activity during the relevant period. The Order also allows participants to supplement the record with additional evidence on CERS transactions in the Pacific Northwest spot market from January 18, 2001 to June 20, 2001. The Order states that parties seeking refunds must submit evidence demonstrating that specific unlawful market activity occurred, and must demonstrate that such activity directly affected negotiations with respect to the specific contract rate about which they complain. Simply alleging a general link between the dysfunctional spot market in California and the Pacific Northwest spot market will not be sufficient to establish a causal connection between a particular seller’s alleged unlawful activities and the specific contract negotiations at issue. Claimants filed notice of their claims on August 17, 2012, and they filed their direct testimony on September 21, 2012. Respondents’ answering testimony is due November 28, 2012; staff’s answering testimony is due January 15, 2013; and respondents’ cross-answering testimony is due February 13, 2013. Claimants’ rebuttal testimony is due March 8, 2013. The hearing is scheduled to begin on April 15, 2013. On July 11, 2012, Avista Energy and Avista Utilities filed settlements of all issues in this docket with regard to the claims made by the City of Tacoma. On September 21, 2012, and September 26, 2012, the FERC issued orders approving the settlements between the City of Tacoma and Avista Utilities and Avista Energy, respectively, thus terminating those claims. The two remaining direct claimants against Avista Utilities and Avista Energy in this proceeding are the City of Seattle, Washington, and the California Attorney General (on behalf of CERS).

Both Avista Utilities and Avista Energy were buyers and sellers of energy in the Pacific Northwest energy market during the period between December 25, 2000 and June 20, 2001 and, are subject to potential claims in this proceeding, and if refunds are ordered by the FERC with regard to any particular contract, could be liable to make payments. The Company cannot predict the outcome of this proceeding or the amount of any refunds that Avista Utilities or Avista Energy could be ordered to make. Therefore, the Company cannot predict the potential impact the outcome of this matter could ultimately have on the Company’s results of operations, financial condition or cash flows.

AVISTA CORPORATION

California Attorney General Complaint (the “Lockyer Complaint”)

In May 2002, the FERC conditionally dismissed a complaint filed in March 2002 by the California AG that alleged violations of the FPA by the FERC and all sellers (including Avista Corp. and its subsidiaries) of electric power and energy into California. The complaint alleged that the FERC’s adoption and implementation of market-based rate authority was flawed and, as a result, individual sellers should refund the difference between the rate charged and a just and reasonable rate. In May 2002, the FERC issued an order dismissing the complaint. In September 2004, the Ninth Circuit upheld the FERC’s market-based rate authority, but held that the FERC erred in ruling that it lacked authority to order refunds for violations of its reporting requirement. The Court remanded the case for further proceedings.

In March 2008, the FERC issued an order establishing a trial-type hearing to address “whether any individual public utility seller’s violation of the FERC’s market-based rate quarterly reporting requirement led to an unjust and unreasonable rate for that particular seller in California during the 2000-2001 period.” Purchasers in the California markets were given the opportunity to present evidence that “any seller that violated the quarterly reporting requirement failed to disclose an increased market share sufficient to give it the ability to exercise market power and thus cause its market-based rates to be unjust and unreasonable.” In March 2010, the Presiding ALJ granted the motions for summary disposition and found that a hearing was “unnecessary” because the California AG, CPUC, PG&E and SCE “failed to apply the appropriate test to determine market power during the relevant time period.” The judge determined that “[w]ithout a proper showing of market power, the California Parties failed to establish a prima facie case.” In May 2011, the FERC affirmed “in all respects” the ALJ’s decision. In June 2011, the California AG, CPUC, PG&E and SCE filed for rehearing of that order. Those rehearing requests were denied by the FERC on June 13, 2012. On June 20, 2012, the California AG, CPUC, PG&E and SCE filed a petition for review of the FERC’s order with the Ninth Circuit.

Based on information currently known to the Company’s management, the Company does not expect that this matter will have a material effect on its financial condition, results of operations or cash flows.

Colstrip Generating Project Complaint

In March 2007, two families that own property near the holding ponds from Units 3 & 4 of the Colstrip Generating Project (Colstrip) filed a complaint against the owners of Colstrip and Hydrometrics, Inc. in Montana District Court. Avista Corp. owns a 15 percent interest in Units 3 & 4 of Colstrip. The plaintiffs allege that the holding ponds and remediation activities have adversely impacted their property. They allege contamination, decrease in water tables, reduced flow of streams on their property and other similar impacts to their property. They also seek punitive damages, attorney’s fees, an order by the court to remove certain ponds, and the forfeiture of profits earned from the generation of Colstrip. In September 2010, the owners of Colstrip filed a motion with the court to enforce a settlement agreement that would resolve all issues between the parties. In October 2011, the court issued an order, which enforces the settlement agreement. The plaintiffs have subsequently appealed the court’s decision and in September 2012 the Montana Supreme Court heard arguments on the appeal, and a decision is pending. Under the settlement, Avista Corp.’s portion of payment (which was accrued in 2010) to the plaintiffs was not material to its financial condition, results of operations or cash flows. Although the final resolution of this complaint remains uncertain, based on information currently known to the Company’s management, the Company does not expect this complaint will have a material effect on its financial condition, results of operations or cash flows.

Sierra Club and Montana Environmental Information Center Notice

On July 30, 2012, Avista Corp. received a Notice of Intent to Sue for violations of the Clean Air Act at Colstrip Steam Electric Station (Notice) from counsel on behalf of the Sierra Club and the Montana Environmental Information Center (MEIC), an Amended Notice was received on September 4, 2012, and a Second Amended Notice was received on October 1, 2012. The Notice, Amended Notice, and Second Amended Notice were all addressed to the Owner or Managing Agent of Colstrip, and to the other Colstrip co-owners: PPL Montana, Puget Sound Energy, Portland General Electric Company, NorthWestern Energy and PacifiCorp. The Notice alleges certain violations of the Clean Air Act, including the New Source Review, Title V and opacity requirements. The Amended Notice alleges additional opacity violations at Colstrip, and the Second Amended Notice alleges additional Title V allegations. All three notices state that Sierra Club and MEIC will request a United States District Court to impose injunctive relief and civil penalties, require a beneficial environmental project in the areas affected by the alleged air pollution and require reimbursement of Sierra Club’s and MEIC’s costs of litigation and attorney’s fees. Under the Clean Air Act, lawsuits cannot be filed until 60 days after the applicable notice date. Avista Corp. is evaluating the allegations set forth in the Notice, Amended Notice and Second Amended Notice, and cannot at this time predict the outcome of this matter.

AVISTA CORPORATION

Harbor Oil Inc. Site

Avista Corp. used Harbor Oil Inc. (Harbor Oil) for the recycling of waste oil and non-PCB transformer oil in the late 1980s and early 1990s. In June 2005, the Environmental Protection Agency (EPA) Region 10 provided notification to Avista Corp. and several other parties, as customers of Harbor Oil, that the EPA had determined that hazardous substances were released at the Harbor Oil site in Portland, Oregon and that Avista Corp. and several other parties may be liable for investigation and cleanup of the site under the Comprehensive Environmental Response, Compensation, and Liability Act, commonly referred to as the federal “Superfund” law, which provides for joint and several liability. The initial indication from the EPA is that the site may be contaminated with PCBs, petroleum hydrocarbons, chlorinated solvents and heavy metals. Six potentially responsible parties, including Avista Corp., signed an Administrative Order on Consent with the EPA on May 31, 2007 to conduct a remedial investigation and feasibility study (RI/FS). The draft final RI/FS was submitted to the EPA in December 2011 and was accepted as pre-final in March 2012. The EPA indicated in their approval letter that they intend to recommend a finding of No Further Action later in 2012. The actual cleanup, if any, will not occur until the RI/FS is finalized and approved by the EPA. Based on the review of its records related to Harbor Oil, the Company does not believe it is a major contributor to this potential environmental contamination based on the small volume of waste oil it delivered to the Harbor Oil site. As such, the Company does not expect that this matter will have a material effect on its financial condition, results of operations or cash flows. The Company has expensed its share of the RI/FS ($0.5 million) for this matter.

Spokane River Licensing

The Company owns and operates six hydroelectric plants on the Spokane River. Five of these (Long Lake, Nine Mile, Upper Falls, Monroe Street, and Post Falls) are regulated under one 50-year FERC license issued in June 2009 and are referred to as the Spokane River Project. The sixth, Little Falls, is operated under separate Congressional authority and is not licensed by the FERC. The license incorporated the 4(e) conditions that were included in the December 2008 Settlement Agreement with the United States Department of Interior and the Coeur d’Alene Tribe, as well as the mandatory conditions that were agreed to in the Idaho 401 Water Quality Certifications and in the amended Washington 401 Water Quality Certification.

As part of the Settlement Agreement with the Washington Department of Ecology (DOE), the Company has participated in the Total Maximum Daily Load (TMDL) process for the Spokane River and Lake Spokane, the reservoir created by Long Lake Dam. On May 20, 2010, the EPA approved the TMDL and on May 27, 2010, the DOE filed an amended 401 Water Quality Certification with the FERC for inclusion into the license. The amended 401 Water Quality Certification includes the Company’s level of responsibility, as defined in the TMDL, for low dissolved oxygen levels in Lake Spokane. The Company submitted a draft Water Quality Attainment Plan for Dissolved Oxygen to the DOE in May 2012 and this was approved by the DOE in September 2012. This has now been submitted to the FERC for their approval. It is not possible to provide cost estimates at this time because the mitigation measures have not been fully approved by the FERC. However, management believes any potential costs would not be material. On July 16, 2010, the City of Post Falls and the Hayden Area Regional Sewer Board filed an appeal with the United States District Court for the District of Idaho with respect to the EPA’s approval of the TMDL. The Company, the City of Coeur d’Alene, Kaiser Aluminum and the Spokane River Keeper subsequently moved to intervene in the appeal. In September 2011, the EPA issued a stay to the litigation that will be in effect until either the permits are issued and all appeals and challenges are complete or the court lifts the stay. The EPA and the Idaho Department of Environmental Quality (Idaho DEQ) are preparing draft National Pollutant Discharge Elimination System permits and the 401 Water Quality Certifications for the Idaho dischargers, respectively, which once issued will be released for a 30-day public comment period.

The IPUC and the WUTC approved the recovery of licensing costs through the general rate case settlements in 2009. The Company will continue to seek recovery, through the ratemaking process, of all operating and capitalized costs related to implementing the license for the Spokane River Project.

Cabinet Gorge Total Dissolved Gas Abatement Plan

Dissolved atmospheric gas levels in the Clark Fork River exceed state of Idaho and federal water quality standards downstream of the Cabinet Gorge Hydroelectric Generating Project (Cabinet Gorge) during periods when excess river flows must be diverted over the spillway. In 2002, the Company submitted a Gas Supersaturation Control Program (GSCP) to the Idaho DEQ and U.S. Fish and Wildlife Service (USFWS). This submission was part of the Clark Fork Settlement Agreement for licensing the use of Cabinet Gorge. The GSCP provided for the possible opening and modification of two diversion tunnels around Cabinet Gorge to allow streamflow to be diverted when flows are in excess of powerhouse capacity. In 2007, engineering studies determined that the tunnels would not sufficiently reduce Total Dissolved Gas (TDG). In consultation with the Idaho DEQ and the USFWS, the Company developed an addendum to the GSCP. The GSCP addendum abandons the concept to reopen the two diversion tunnels and requires the Company to evaluate a variety of different options to abate TDG. In March 2010, the FERC approved the GSCP addendum of preliminary design for alternative abatement measures. In the second quarter of 2011, the Company completed preliminary feasibility assessments for several alternative abatement measures and determined that two alternatives will be considered for continued development. Further analysis and review of these alternatives is expected to be completed through 2012. The Company will continue to seek recovery, through the ratemaking process, of all operating and capitalized costs related to this issue.

AVISTA CORPORATION

Fish Passage at Cabinet Gorge and Noxon Rapids

In 1999, the USFWS listed bull trout as threatened under the Endangered Species Act. The Clark Fork Settlement Agreement describes programs intended to help restore bull trout populations in the project area. Using the concept of adaptive management and working closely with the USFWS, the Company is evaluating the feasibility of fish passage at Cabinet Gorge and Noxon Rapids. The results of these studies led, in part, to the decision to move forward with development of permanent facilities, among other bull trout enhancement efforts. In 2009, the Company selected a contractor to design a permanent upstream passage facility at Cabinet Gorge. The Company anticipates that the design and cost estimates will be completed by the end of 2012 with construction taking place in 2013 and 2014.

In January 2010, the USFWS revised its 2005 designation of critical habitat for the bull trout to include the lower Clark Fork River as critical habitat. The Company believes its ongoing efforts through the Clark Fork Settlement Agreement continue to effectively address issues related to bull trout. The Company will continue to seek recovery, through the ratemaking process, of all operating and capitalized costs related to fish passage at Cabinet Gorge and Noxon Rapids.

Aluminum Recycling Site

In October 2009, the Company (through its subsidiary Pentzer Venture Holdings II, Inc. (Pentzer)) received notice from the DOE proposing to find Pentzer liable for a release of hazardous substances under the Model Toxics Control Act, under Washington state law. Pentzer owns property that adjoins land owned by the Union Pacific Railroad (UPR). UPR leased their property to operators of a facility designated by the DOE as “Aluminum Recycling – Trentwood.” Operators of the UPR property maintained piles of aluminum “black dross,” which can be designated as a state-only dangerous waste in Washington State. In the course of its business, the operators placed a portion of the aluminum dross pile on the property owned by Pentzer. Pentzer does not believe it is a contributor to any environmental contamination associated with the dross pile, and submitted a response to the DOE’s proposed findings in November 2009. In December 2009, Pentzer received notice from the DOE that it had been designated as a potentially liable party for any hazardous substances located on this site. UPR completed a RI/FS Work Plan in June 2010. At that time, UPR requested a contribution from Pentzer towards the cost of performing the RI/FS and also an access agreement to investigate the material deposited on the Pentzer property. Pentzer concluded an access agreement with UPR in October 2010. UPR completed the RI/FS during 2011. Based on information currently known to the Company’s management, the Company does not expect this issue will have a material effect on its financial condition, results of operations or cash flows.

Other Contingencies

In the normal course of business, the Company has various other legal claims and contingent matters outstanding. The Company believes that any ultimate liability arising from these actions will not have a material impact on its financial condition, results of operations or cash flows. It is possible that a change could occur in the Company’s estimates of the probability or amount of a liability being incurred. Such a change, should it occur, could be significant.

NOTE 12. INFORMATION BY BUSINESS SEGMENTS

The business segment presentation reflects the basis used by the Company’s management to analyze performance and determine the allocation of resources. Avista Utilities’ business is managed based on the total regulated utility operation. Ecova is a provider of facility information and cost management services for multi-site customers throughout North America. The Other category, which is not a reportable segment, includes Spokane Energy, other investments and operations of various subsidiaries, as well as certain other operations of Avista Capital.

AVISTA CORPORATION

The following table presents information for each of the Company’s business segments (dollars in thousands):


	Avista Utilities		Ecova		Other			Total Non- Utility			Intersegment Eliminations (1)			Total


For the three months ended September 30, 2012:
Operating revenues	$	292,535	$	38,617	$	9,930		$	48,547		$	(450	)	$	340,632
Resource costs		153,801		—		—			—			—			153,801
Other operating expenses		64,449		33,868		9,229			43,097			(450	)		107,096
Depreciation and amortization		28,255		3,260		131			3,391			—			31,646
Income from operations		27,940		1,489		570			2,059			—			29,999
Interest expense (2)		18,001		530		824			1,354			(91	)		19,264
Income taxes		2,590		495		(1,477	)		(982	)		—			1,608
Net income attributable to Avista Corporation		7,660		640		(2,514	)		(1,874	)		—			5,786
Capital expenditures		57,964		1,023		619			1,642			—			59,606
For the three months ended September 30, 2011:
Operating revenues	$	302,001	$	32,228	$	9,931		$	42,159		$	(450	)	$	343,710
Resource costs		171,393		—		—			—			—			171,393
Other operating expenses		60,579		23,790		8,386			32,176			(450	)		92,305
Depreciation and amortization		26,341		1,784		180			1,964			—			28,305
Income from operations		26,859		6,654		1,365			8,019			—			34,878
Interest expense (2)		17,639		71		1,150			1,221			(5	)		18,855
Income taxes		1,546		2,416		(245	)		2,171			—			3,717
Net income attributable to Avista Corporation		7,582		3,467		(347	)		3,120			—			10,702
Capital expenditures		69,716		897		233			1,130			—			70,846
For the nine months ended September 30, 2012:
Operating revenues	$	992,210	$	115,707	$	29,907		$	145,614		$	(1,350	)	$	1,136,474
Resource costs		500,805		—		—			—			—			500,805
Other operating expenses		191,407		104,392		27,285			131,677			(1,350	)		321,734
Depreciation and amortization		83,327		9,455		511			9,966			—			93,293
Income from operations		153,049		1,860		2,111			3,971			—			157,020
Interest expense (2)		54,148		1,301		2,691			3,992			(274	)		57,866
Income taxes		34,425		918		(2,237	)		(1,319	)		—			33,106
Net income attributable to Avista Corporation		65,157		962		(3,767	)		(2,805	)		—			62,352
Capital expenditures		178,440		3,248		660			3,908			—			182,348
For the nine months ended September 30, 2011:
Operating revenues	$	1,060,571	$	91,207	$	30,425		$	121,632		$	(1,350	)	$	1,180,853
Resource costs		575,290		—		—			—			—			575,290
Other operating expenses		188,961		72,220		24,711			96,931			(1,350	)		284,542
Depreciation and amortization		78,600		5,086		587			5,673			—			84,273
Income from operations		156,199		13,901		5,127			19,028			—			175,227
Interest expense (2)		52,134		206		3,912			4,118			(382	)		55,870
Income taxes		35,857		5,005		75			5,080			—			40,937
Net income attributable to Avista Corporation		68,733		7,016		(128	)		6,888			—			75,621
Capital expenditures		169,598		2,173		557			2,730			—			172,328
Total Assets:
As of September 30, 2012	$	3,732,530	$	357,457	$	100,269		$	457,726		$	—		$	4,190,256
As of December 31, 2011	$	3,809,446	$	292,940	$	112,145		$	405,085		$	—		$	4,214,531

(1)	Intersegment eliminations reported as operating revenues and resource costs represent intercompany purchases and sales of electric capacity and energy. Intersegment eliminations reported as interest expense represent intercompany interest.

(2)	Including interest expense to affiliated trusts.

AVISTA CORPORATION

NOTE 13. SUBSEQUENT EVENTS

On October 22, 2012, the Company announced a voluntary severance incentive program. The Company has concluded that in order to achieve necessary long-term, Company-wide savings, it must undergo a reduction in its total workforce to reduce employment and related costs.

In general, all employees of Avista Corp. (not including any of its subsidiaries) who are not covered by a collective bargaining agreement are eligible to participate in the program. Employees who elect to participate in the program will be terminated only upon approval by the Company’s management.

Each participant in the program will be entitled to receive severance pay determined based on the participant’s years of service and base pay as of December 31, 2012. In no event will the severance pay under the program exceed 78 weeks of a participant’s base pay. Severance pay will be distributed in a single lump sum cash payment to each participant as soon as administratively practicable after December 31, 2012 and in no event later than February 1, 2013.

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 upon acceptance and cannot be reasonably estimated at this time.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

Avista Corporation

Spokane, Washington

We have reviewed the accompanying condensed consolidated balance sheet of Avista Corporation and subsidiaries (the “Company”) as of September 30, 2012, and the related condensed consolidated statements of income and of comprehensive income, for the three-month and nine-month periods ended September 30, 2012 and 2011, and of equity and redeemable noncontrolling interests, and cash flows for the nine-month periods ended September 30, 2012 and 2011. These interim financial statements are the responsibility of the Company’s management.

We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our reviews, we are not aware of any material modifications that should be made to such condensed consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Avista Corporation and subsidiaries as of December 31, 2011, and the related consolidated statements of income, comprehensive income, equity and redeemable noncontrolling interests, and cash flows for the year then ended (not presented herein); and in our report dated February 28, 2012, we expressed an unqualified opinion on those consolidated financial statements, which included an explanatory paragraph related to the adoption of accounting guidance for variable interest entities. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2011 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

/s/ Deloitte & Touche LLP

Seattle, Washington

November 7, 2012

AVISTA CORPORATION

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.

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.

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 existin

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