AVA

Business Context and Reporting Period

Company: Avista Corporation (Avista Corp.)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2003
Headquarters: Spokane, Washington

Avista Corp. is an energy company engaged in the generation, transmission, and distribution of energy. Its operations are divided into four segments: Avista Utilities (regulated electric and natural gas utility operations), Energy Marketing and Resource Management (trading and resource optimization via Avista Energy and Avista Power), Avista Advantage (utility bill processing services), and Other (various non-utility investments). The company serves approximately 325,000 electric and 298,000 natural gas retail customers across eastern Washington, northern Idaho, Oregon, and California.

Key Financial Metrics (2003)

Material Changes vs. Prior Period

• Revenue Growth: Total operating revenues increased 5.7% to $1.12 billion, driven by a 38% increase in Energy Marketing revenues (due to accounting changes and Enron settlements) and a 4% increase in Avista Utilities revenues (higher electric rates and sales volumes).
• Profitability: Net income increased 42% to $44.5 million. This was primarily due to reduced losses in the "Other" and "Avista Advantage" segments and improved gross margins in Avista Utilities, partially offset by a decrease in Energy Marketing net income.
• Cash Flow Decline: Operating cash flow dropped significantly to $122.6 million from $326.9 million in 2002. This decrease was attributed to reduced amortization of deferred power/gas costs, changes in working capital (specifically accounts payable), and a decrease in unrealized losses on energy trading activities.
• Debt Levels: Total debt increased by approximately $144 million. This increase was largely due to the adoption of FASB Interpretation No. 46 (consolidating WP Funding LP and deconsolidating preferred trust securities) and an increase in short-term borrowings, partially offset by debt repurchases.

Guidance, Outlook, and Risks

Management Outlook

• Avista Utilities: Management expects net income to increase in 2004 compared to 2003, assuming normal hydroelectric production (forecast at 95% of normal), normal weather, and the implementation of general rate increases filed in Idaho.
• Energy Marketing: Net income is expected to decrease in 2004 compared to 2003, primarily due to the one-time positive effects of accounting transitions (SFAS No. 133) and Enron settlements realized in 2003.
• Avista Advantage: Expected to be break-even or generate slightly positive net income in 2004.
• Other Segment: Expected to show a reduced net loss in 2004 due to the resolution of prior legal matters.

Key Risks and Contingencies

• Regulatory Proceedings: Significant uncertainty remains regarding the recovery of deferred power costs in Washington and Idaho. The Washington Utilities and Transportation Commission (WUTC) ordered the termination of the Natural Gas Benchmark Mechanism in Washington, requiring a transition of procurement functions back to Avista Utilities.
• FERC Investigations: An agreement in resolution regarding FERC investigations into market conduct during 2000-2001 was certified by an administrative law judge in July 2003 but remained pending final approval by FERC commissioners as of the filing date.
• Environmental Liabilities: The company faces potential costs related to the Spokane River PCB contamination (estimated share <$1.0 million) and the Cabinet Gorge hydroelectric project (estimated $60 million for tunnel modifications to mitigate dissolved gas levels).
• Hydroelectric Reliance: Operations are sensitive to streamflow conditions. While 2003 was 89% of normal, future production depends on precipitation and snowpack.
• Counterparty Credit Risk: The company monitors credit exposure in wholesale energy markets, particularly following the bankruptcy of Mirant Corporation (though Mirant Oregon, a joint venture partner, remained current).

Investor Verification Checklist

• Deferred Cost Recovery: Verify the status of the $156 million in deferred power costs and $15.4 million in deferred natural gas costs, specifically the prudence reviews by the WUTC and IPUC.
• FERC Settlement Status: Confirm the final approval status of the FERC agreement in resolution regarding 2000-2001 market conduct investigations.
• Accounting Changes: Review the impact of SFAS No. 133 and FIN 46 on the comparability of 2003 results versus prior years, particularly regarding energy trading volatility and debt classification.
• Hydroelectric Forecasts: Monitor actual streamflow conditions in 2004 against the 95% of normal forecast to assess potential impacts on power supply costs.
• Debt Covenants: Confirm continued compliance with the 65% debt-to-capitalization covenant on the $245 million line of credit, especially given the recent increase in short-term borrowings.