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Avista Corporation 10-Q Summary: Period Ended September 30, 2002

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended September 30, 2002, and the nine months ended September 30, 2002, for Avista Corporation. Avista is an energy company operating in four segments: Avista Utilities (regulated electric and natural gas), Energy Trading and Marketing (non-regulated trading), Information and Technology, and Other. The company is currently divesting its Avista Communications business, which is reported as discontinued operations.

Key Financial Metrics

Note: 2001 Net Income included a significant loss from discontinued operations ($44.4M) due to asset impairments, whereas 2002 discontinued operations resulted in a small net income ($0.2M).

Material Changes vs. Prior Period

• Revenue Decline: Operating revenues decreased 34% ($362M) year-over-year. This was driven by a 64% drop in Energy Trading and Marketing revenues due to reduced market volatility and lower commodity prices, and a 30% drop in Avista Utilities revenues due to lower wholesale electric sales volumes and prices.
• Profitability Shift: Income from continuing operations fell 63% ($40.4M) primarily due to reduced margins in the Energy Trading segment. However, Avista Utilities gross margin increased $26.8M due to lower resource costs (power and fuel) and rate increases approved by regulators.
• Cash Flow Improvement: Net cash provided by operating activities swung from a $95.8M outflow in 2001 to a $281.6M inflow in 2002. This improvement is largely attributed to the amortization of deferred power and natural gas costs ($66.5M) and improved working capital management.
• Debt Reduction: Total debt decreased by approximately $166M. The company repurchased $200.3M of long-term debt during the period, utilizing improved operating cash flows.

Guidance, Outlook, and Risks

• Earnings Guidance: Management expects full-year 2002 diluted earnings per share (EPS) between $0.60 and $0.70. For 2003, EPS is projected in the range of $0.80 to $1.00.
• Regulatory Matters: The Washington Utilities and Transportation Commission (WUTC) approved a general rate case in June 2002, restructuring rate increases to recover deferred power costs through 2008. An Energy Recovery Mechanism (ERM) was implemented to manage future power cost fluctuations.
• Accounting Changes: The company adopted SFAS No. 142 (Goodwill), recording a $4.1M impairment charge as a cumulative effect of accounting change. Additionally, the rescission of EITF Issue No. 98-10 in October 2002 requires a transition to SFAS No. 133 for derivative accounting, the impact of which is currently being evaluated.
• Legal and Regulatory Risks:
  • FERC Investigation: The Federal Energy Regulatory Commission (FERC) initiated an investigation into potential misconduct regarding trading strategies with Enron affiliates. Hearings are scheduled for April 2003.
  • Enron Bankruptcy: The company has settled most contracts with Enron affiliates. Management estimates no significant loss due to non-collection, though residual obligations are being negotiated.
  • California Markets: The company faces potential refund claims and litigation related to California energy market activities.

Investor Verification Checklist

• Deferred Cost Recovery: Verify the timeline and regulatory approval for the recovery of $153.7M in deferred power costs, which is critical to future cash flows.
• Accounting Transition Impact: Monitor the financial impact of transitioning from EITF 98-10 to SFAS 133 for energy trading derivatives, effective January 1, 2003.
• FERC Investigation Outcome: Track the progress of the FERC investigation into trading practices and potential financial penalties or rate revocations.
• Enron Settlements: Confirm the finalization of all settlement agreements with Enron affiliates to ensure no material residual liabilities exist.
• Hydroelectric Conditions: Assess the impact of streamflow conditions on generation costs and the need for purchased power in the upcoming year.