AVA

Business Context and Reporting Period

This Form 10-Q covers The Washington Water Power Company (announced name change to Avista Corporation effective January 1, 1999) for the quarterly and nine-month periods ended September 30, 1998. The company operates as a regional utility providing electric and natural gas services (Energy Delivery and Generation and Resources) and a national entity (Avista Capital) managing energy trading and non-energy businesses.

Key Financial Metrics

Segment Performance (Nine Months 1998): Energy Delivery contributed $37.7 million to income available for common stock. Generation and Resources contributed $37.7 million (combined with Energy Delivery in the segment table, but noted separately in MD&A as having decreased earnings). National Energy Trading and Marketing contributed $5.7 million. Non-energy operations contributed $11.0 million.

Material Changes vs. Prior Period

• Revenue Growth: Operating revenues increased significantly from $815.4 million in the prior year to $2.66 billion, driven primarily by a massive expansion in National Energy Trading and Marketing volumes (revenues rose from $51.6 million to $1.75 billion).
• Profit Decline: Net income available for common stock decreased from $87.0 million in 1997 to $54.4 million in 1998. This decline is largely attributed to a one-time $41.4 million after-tax income tax recovery received in 1997 that did not recur.
• Utility Operations: Generation and Resources pre-tax income dropped 55% year-over-year due to lower hydroelectric generation (21% lower streamflows) necessitating expensive purchased power, and a shift in sales mix toward lower-margin short-term contracts.
• Non-Energy: Earnings remained flat at $11.0 million, with a decrease in transactional gains offset by increased non-transactional income from portfolio companies.

Guidance, Outlook, and Risks

• Dividend Restructuring: The company announced a reduction in the common stock dividend from $1.24 to $0.48 per share (a 61% reduction), effective December 15, 1998. This is part of a plan to fund strategic growth initiatives.
• Capital Expenditures: Estimated capital expenditures for 1999-2000 are projected to range between $400 million and $600 million to support growth, funded by cash flows, asset sales, and additional debt.
• Exchange Offer: An exchange offer was commenced on October 21, 1998, allowing shareholders to exchange common stock for mandatorily convertible preferred stock (Series L) to facilitate the dividend restructuring.
• Year 2000 Compliance: The company estimates incremental costs of $4-6.5 million for Y2K remediation, with $2.2 million spent through September 30, 1998. Risks include potential disruptions from external suppliers and the regional electric grid.
• Legal Contingencies: Significant litigation includes a lawsuit by the Nez Perce Tribe regarding fish passage at former dams (potential damages $425-650 million plus punitive damages), an oil spill remediation dispute with an insurance carrier (seeking over $16 million), and a recent suit by Eastern Pacific Energy alleging breach of a joint venture agreement.
• Regulatory Action: The FERC issued a show cause order regarding alleged violations of affiliate conduct rules, resulting in a 180-day suspension of certain market-based power sales tariffs and a requirement to disgorge profits (deemed not material).

Investor Verification Checklist

• Verify the impact of the 61% dividend reduction on shareholder returns and the company's liquidity position.
• Assess the sustainability of National Energy Trading and Marketing earnings given the high volatility and mark-to-market accounting risks described.
• Monitor the status of the Nez Perce Tribe litigation and the potential for material liability.
• Review the progress of the Year 2000 remediation project, specifically regarding external dependencies on the regional transmission grid.
• Confirm the execution of the common stock exchange offer for Series L preferred stock and its effect on the capital structure.